Wealth Managers

Bull Market as 55-64 Age Group Doubles?

2012-02-16T11:40:00.000-08:00

Financial Planning Article by Tom Steinhert-Threlkeld

Quote by Bill Dwyer of LPL Financial....

"In 1988, there were roughly 22 million Americans between the ages of 55 and 64. Those are the years when the amount of retirement funds in a household expand by 46 percent, Dwyer said.

By 2008, that was up to 33 million Americans and this will peak at 43 million in 2020. That means the numbers of Americans in the key age bracket will be twice as large as in 1988. And … these individuals will have three to four times the assets under their control than their parents did."

As the number of investors in this 55-64 "pre-retirement" age group grows in number, sooner or later, history teaches that a large portion of their funds go into equities. When demand increases, usually prices rise as well.

As I have stated previously, it is impossible to tell when sentiment changes from it's present pessimistic bent, but when it does, it is likely markets will be surprisingly strong. It's looking a bit like the late 1970's, absent the inflation and high interest rates.

This information/opinion 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 those quoted, 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.

Europe? Maybe price of gasoline/diesel is more important?

2012-02-16T08:47:00.000-08:00

Informative articles in Morningstar Advisor about Europe:

http://www.morningstar.com/advisor/morningstar-advisor-magazine.htm

How Europe is Making Its Crisis Worse

Impact on US Economy Will Be Minimal

Bottom line:

Bonds that were once thought as "safe" turned out not to be so safe. And, with 14% of US GDP related to exports, and 22% of that to Europe--Exports to Europe are 3.1% of US GDP. A 6% decline in sales to Europe would only be a 0.2 % change in US GDP.

While the market seems focused on Europe--watch out for inflating prices, particularly oil and gasoline. A big rise in gasoline prices is thought by many to be the spark that led to the 2008 decline. People are better prepared today, but it could have a major impact on economic growth in 2012.

This information/opinion 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 those quoted, 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

Don't Fight the Last War

2012-01-31T11:31:00.000-08:00

In November, I wrote that Stock and Bond markets around the world were then what I called “Fraidy Cat Markets” where every possible threat was thought by many to surely lead to economic catastrophe. On the other hand, there was fear that perhaps the pessimism was overdone and many had inordinate fear of “missing out” on a massive upturn. As I have said, “Mr. Market” suffers hopelessly from manic-depressive syndrome. After a pretty disappointing 2011 where the only certainty was uncertainty, January’s “recovery from the depths” was being called a “rally”. Then on January 25^th, worry took over and markets started to head down a little, again.

To put things in perspective, the S&P500 is around 4% LOWER than it’s 2011 peak, and it would have to rise 20% to reach it’s “all time high” last set in 2007, more than four years ago.

To many, the market is grossly undervalued. To others, looking at the same data, the market is set for a fall. My take on this is that we are in an age of pessimism, much like the 1970’s. Bad, unexpected things have happened to us. Many of us fear that more bad things are coming…again. Also, the whole world is still recovering from a huge “debt hangover”. History teaches such times when debts need to be repaid or excess capacity absorbed can be pretty depressing, psychologically, if not economically. But, for the most part, economics and markets are affected by psychology.

Negative psychology or “pessimism” is a headwind causing caution and an undervalued market. Anything bad that happens may make it worse—in the short run. This is always a risk for investors. Anything bad that happens can make investments fall in value—in the short run.

I’m clearly one that believes markets are currently grossly undervalued. Other than in the US, almost every country in the world has been fighting inflation. (Most governments and many investors tend use strategies of the “last war” until they realize they are wrong.) Governments had been “tightening” by raising interest rates and/or restricting credit, and/or by raising bank capital requirements. In late 2011, this situation completely reversed with now almost every country in the world “stimulating” by cutting interest rates and encouraging credit expansion. It’s as if the entire world took their foot off the brake and mashed the throttle down to wide open.

For many years investors have been warned against “fighting the Fed” meaning, that when governments “stimulate” their money supply, economies tend to grow faster, not slower. Assets tend to go up in value. The risk is not usually small growth, but rather big inflation. Today the “Fed” is being joined by almost every other central bank in the whole world.

Only God knows the future. So be prepared for the unexpected. Be cautious and stay diversified. But, wisdom and history teaches us that asset prices and interest rates are probably headed up not down in the longer run—especially when government central banks are easing to this extent. True, borrowing and printing money have ramifications---usually the biggest ramification is inflation.

For the long term investor, this time will probably prove to be an above average opportunity for growth in stock markets. The biggest risk I see being is what few are telling us about—namely inflation.

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.

Professional Advice--Worth the Price?

2011-11-30T12:53:00.000-08:00

Here is an excerpt from an article at CNNMoney by Walter Updegrave (See link for entire article)

"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.

Link to: Should I Hire a Financial Adviser or Go It Alone?

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

2011-11-17T07:11:00.000-08:00

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.

Fraidy Cat Markets

2011-11-15T09:00:00.000-08:00

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.

Risk Neutral Investing in Uncertain Times

2011-09-27T12:45:00.000-07:00

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.

Income Groups over 40 Years

2011-09-15T12:38:00.000-07:00

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.

Federal Income Tax Burden by Income Group

2011-09-14T09:46:00.000-07:00

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.

2011 Market Performance by Country

2011-09-12T07:14:00.000-07:00

http://www.bespokeinvest.com/

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

2011-08-22T09:26:00.000-07:00

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:

James Kostohryz's article

What Next? Is it like 2008 or 2010?

2011-08-19T11:01:00.000-07:00

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.

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.

Worried about Greece?

2011-06-24T11:38:00.000-07:00

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:

http://www.emta.org/template.aspx?id=34

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:

http://www.ceps.eu/book/debt-reduction-without-messy-default

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.

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

2011-06-23T10:33:00.000-07:00

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.

Who Moved My Cheese?

2011-06-11T12:00:00.000-07:00

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).

Is Silver (or Gold) a Safe Investment?

2011-04-18T12:51:00.000-07:00

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.

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

2011-04-18T11:15:00.000-07:00

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.

The Wall of Worry Gets Taller

2011-04-16T10:14:00.000-07:00

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.

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

2011-03-16T10:44:00.000-07:00

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.

Climbing the Wall of Worry-Managing Risk

2011-02-26T12:02:00.000-08:00

In our last “post” we shared a video with an interview of Goldman Sach’s, Abby Joseph Cohen, titled “The Drought is Over”. Stock market performance in January and February sure seems consistent with that assessment! The S&P500 has risen 4.95% and the MSCI World Index is up 3.52% for January-February. On the other hand, fixed income did not provide very good returns, with the DJ CBOT Weighted Treasury Index actually declining 0.15%.

Reversing an eight month trend of outflows totaling more than $61 billion, money started returning to US Stock Mutual and Exchange Traded Funds with $26 billion inflows in January. Optimism on the part of many has returned, BUT many worries remain.

While paper earnings appear solid, many believe that banks are hiding skeletons in their closets. House prices continue to fall. Federal stimulus designed to reverse this fall in housing prices has resulted in higher prices in other areas. Inflation, particularly in food prices seems to be one spark, among many causes for uprisings in the Arab world where the average family spends more than 40% of their income on food. Unemployment is still a problem in the US. Sovereign debt in Europe is still a great concern. And, high energy prices threaten to choke off the fragile recovery. Finally, no one is sure of the long term effects of US debt and deficits; and no one is sure of the short term effects of austerity measures to reduce this debt and deficit. To a great extent, the stock market in the US is underestimating these risks.

Investors always have three choices: Buy, Sell or Hold. Clear “Sell” signals were present in 2007. By mid to late 2009, we saw clear “Buy” signals. Since November 2010, our cautious view has been somewhere in between Buy and Hold. Global markets appear fairly valued and the US stock market as a whole appears a bit overvalued. One caution is that markets can continue to be overvalued for quite some time.

For the long term we are bullish and, we like what Warren Buffet had to say in his recent letter to shareholders of Berkshire Hathaway…. http://www.berkshirehathaway.com/2010ar/2010ar.pdf

“Money will always flow toward opportunity, and there is an abundance of that in America. Commentators today often talk of “great uncertainty.” But think back, for example, to December 6,1941, October 18, 1987 and September 10, 2001. No matter how serene today may be, tomorrow is always uncertain.

Don’t let that reality spook you. Throughout my lifetime, politicians and pundits have constantly moaned about terrifying problems facing America. Yet our citizens now live an astonishing six times better than when I was born. The prophets of doom have overlooked the all-important factor that is certain: Human potential is far from exhausted, and the American system for unleashing that potential – a system that has worked wonders for over two centuries despite frequent interruptions for recessions and even a Civil War – remains alive and effective. We are not natively smarter than we were when our country was founded nor do we work harder. But look around you and see a world beyond the dreams of any colonial citizen. Now, as in 1776, 1861, 1932 and 1941, America’s best days lie ahead.”

“It’s easy to identify many investment managers with great recent records. But past results, though important, do not suffice when prospective performance is being judged. How the record has been achieved is crucial, as is the manager’s understanding of – and sensitivity to – risk (which in no way should be measured by beta, the choice of too many academics). In respect to the risk criterion, we were looking for someone (to replace Mr. Buffett over time) with a hard-to-evaluate skill: the ability to anticipate the effects of economic scenarios not previously observed.”

…Warren E. Buffett, February 26, 2011

(BERKSHIRE HATHAWAY INC. 2010 ANNUAL REPORT)

In the short term however, we advise caution and draw your attention to Mr. Buffet’s comments about investment managers needing an “understanding of – and sensitivity to – risk” and “the ability to anticipate the effects of economic scenarios not previously observed”.

I believe that in the short term, there is considerable risk of a correction. Not a 100% probability, but higher than 50%. So, particularly for new money, continued caution is advised. For existing investments, particular attention to quality is important. Attention to individual securities that are possibly overvalued is appropriate.

In addition, I am always careful when the statement “this time is different” is made. This statement is often very dangerous, particularly when it breeds overconfidence. However, I believe that we are presently in one of those “economic scenarios not previously observed” that Mr. Buffett writes about. This is a time when an “understanding of – and sensitivity to – risk” is even more important than it is normally.

Managing risk in the short term may result in a conservative position with higher than average cash positions---and to the average investor, may appear to result in missed opportunity as the “market” rises more than their portfolio does.

In an upward moving market, it is important to recognize “the trend is your friend”. But the trend is a fair-weather friend and can turn at any given time. The trend doesn't announce its intention to change direction. It switches back and worth as it pleases without your permission.

It is important to remember that bull markets climb a “wall of worry” and as Mr. Buffett has said, “Be Greedy when others are fearful..be fearful when others are greedy”. Perhaps today, too many are greedy and not enough are fearful. As soon as that situation reverses, great opportunity for long term gains returns.

2010-12-31T12:59:00.001-08:00

Perspective from Other Respected Advisers

2010-12-23T12:11:00.001-08:00

Link to site at Investment News: http://www.investmentnews.com/section/multimedia

Consuelo Mack WealthTrack

Abby Joseph Cohen: The Drought is Over

Merry Christmas !

2010-12-10T09:40:00.000-08:00

Carol and Wayne wish you and your family a Merry Christmas and a Happy New Year.

http://www.youtube.com/watch?v=LMYm8C6XYlk

Market Commentary 11/29/2010

2010-11-27T12:44:00.001-08:00

End of Month and End of Year Volatility--International Turmoil

Click on this YouTube link:

http://www.youtube.com/watch?v=et81jKq6Ne8

Please remember that Market Commentary for Friends and Clients is for educational purposes only and is not investment advice for any specific individual. Please contact Wayne for any personal investment advice.

This new "Wayne and Carol" interview has been created using new xtranormal.com software that allows typewritten input to be converted to speech. We hope it is more interesting that just printed text, but just as informative and valuable.

Market Commentary 11/15/2010

2010-11-15T15:45:00.000-08:00

A Week with a Great Deal of News!

Click on this private YouTube link:

http://www.youtube.com/watch?v=GeREW-atmAU

Please remember that Market Commentary for Friends and Clients is for educational purposes only and is not investment advice for any specific individual. Please contact Wayne for any personal investment advice.

This new "Wayne and Carol" interview has been created using new xtranormal.com software that allows typewritten input to be converted to speech. We hope it is more interesting that just printed text, but just as informative and valuable.

The Paradox of Global Recovery

2010-10-09T11:39:00.000-07:00

"Originally a paradox was merely a view which contradicted accepted opinion. By round about the middle of the 16th c. the word had acquired the commonly accepted meaning it now has: an apparently self-contradictory statement which, on closer inspection, is found to contain a truth reconciling the conflicting opposites. . . . “ (J.A. Cuddon, A Dictionary of Literary Terms, 3rd ed. Blackwell, 1991)

Even optimistic Americans seem to become a bit uncomfortable when facts and projections about a global “recovery” are discussed. We are used to, since 1945 being the “dominant” economic force in the world and are skeptical when we are told that the world is growing without us being the dominating force for that growth. How can corporate profits be increasing when there is record unemployment in the US and real estate is depressed?

Here’s part of the answer…

The US economy is very big. Even after the recent contraction, it still represents more than $14 trillion per year. (In other words, $14,622 billion.) On an inflation adjusted basis, it is now more than twice as large as it was in 1980. In 1980, a 3.5% annual increase in GDP represented an increase of $227 billion. The US economy in 2010 will probably grow by more than $227 billion. To put this in perspective—the economic output for the entire US will grow more in 2010 than the entire annual economic output of the State of Maryland. In percentage terms, that is slower than in 1980, but in total dollar terms, it is a very big number.

The biggest story however….

Global Trade is now arguably bigger than the total US economy and growing rapidly. Global Trade was in excess of $15 trillion (2009) and forecast to grow by more than 9% in 2010. Companies that are successful and participating in Global Trade are earning profits and the value of their equities (stocks) are rising. But, Global Trade is very competitive and requires a high degree of productivity; It may not contribute to local employment as much as “domestic” business, like residential construction.

The US economy and the economies of some European countries overdosed on residential and retail/commercial real estate during the last 10 years. (Speculation fueled by debt always ends in disaster.) The current difficult part of the US economy in terms of unemployment and declining real estate prices is the “hangover” from that overdosing and binge.

In addition to current Global Trade, consumption outside of the US is growing fast. We used to think of the world economy as three equal parts: the US, Europe, and The Rest of the World. Now, the world economy is four equal parts: the US, Europe, Asia/India, and The Rest of the World. There is now more total wealth in Asia/India than in the US—and therefore, more potential customers for goods and services made by global companies that you can invest in.

Economic activity, estimated to reach nearly $50 trillion for the entire world in 2010 will be the highest in history, having recovered completely from the big drop in 2009—probably exceeding 2008 in real terms by at least 1%. This is despite the fact that the US economy, while “recovering” is still not “recovered”—with GDP for 2010 in the US still slightly below 2007.

Keeping things in perspective: The US has been the world's largest national economy since 1870 and remains the world's largest manufacturer, representing 19% of the world's manufacturing output. Contrary to popular belief, the US was still the largest exporting country in the world for 2009, although Europe as a region, counting only exports outside of Europe exported about 25-30% more. In 2010-2011, China will probably be exporting at levels equal to or higher than the US.

Can the stock market go up and investors prosper, even if the US economy grows slowly?

The answer to that question depends on whether the rest of the world can and will grow without the US in the lead. This has been the debate about what has been termed “economic decoupling”.

My view is that the world will not decouple, but the world economy will become even more inter-dependent. Slow growth in the US will be a drag on global growth. But, the wealth that has been created and accumulated in other parts of the world will no doubt begin to increase demand for US products/services and ultimately bring growth and employment back to historically normal levels. The change is that instead of focusing on producing goods and services for US consumers, our businesses (and their stockholders) will have to shift focus toward satisfying consumers and customers in other countries. The rest of the world will help us to recover from our binge on residential real estate and excess debt.

The paradox of global growth and domestic stagnation is in the truth and simple fact that the huge US economy is having to, and will have to continue to adapt to the reality that for us to prosper, we need to focus not just on selling to and serving ourselves, but the other 95% of the human population living elsewhere as well.

The economy outside the US has recovered and is growing—and the best companies and their stockholders focused on this global economy are prospering accordingly. History teaches us that absent global military conflict, that trend will probably continue.

One caveat is that this global growth could be hurt by ill-advised government actions around the world. Unrestrained real estate speculation and excessive government intervention in China as well as a growing socialist agenda in Brazil are concerns. The growing countries must recognize that continued growth requires an expansion of global trade, which relies on increased imports as well as exports. The US has reached its limit in terms of capacity to absorb the world’s exports without a corresponding increase in reciprocal trade.

Let’s also hope that our government soon wakes up and recognizes that our future leadership in the world lies not in wealth re-distribution and expensive military adventures, but wealth creation in a very competitive world. A competitive, productive workforce, supported by a business friendly government and a superior infrastructure, creates employment and prosperity.

Is This Time Different?

2010-09-18T13:09:00.000-07:00

In a past issue of Forbes Magazine, Gabriel Wisdom wrote an article titled “The Four Phases of Market Cycles”. Phase I: Pessimism and Abject Fear; Phase II: Skepticism; Phase III: Optimism; and Phase IV: Euphoria.

I wrote last month that “Our economy is clearly “recovering” from a financial crisis, but we have not yet “recovered”. The trip is not over, and we are not there yet.” I think that it can be safely said that for the most part we are in Phase II: Skepticism. Markets have risen dramatically from their lows, but recent declines in June and August had caused some to even fear that we had fallen back into Phase I.

According to Mr. Wisdom, “If you wait for optimism, you missed it.” This is sort of like Warren Buffet’s quote: “If you wait till you see the Robins, Spring has already arrived.”

The important point to remember, is that your investment strategy must ANTICIPATE the movement from one phase to another. If you wait until the markets enter Phase III: Optimism—then you will have missed most of the upside. The time to be fearful is during Phase IV: Euphoria.

Many investors are rightly disturbed by the negative uncertainty of high unemployment, a terrible real estate market, excessive debt, government deficits, and potentially rising tax rates. Even though corporate profits have risen back to pre-crisis levels, the market is skeptical that the numbers are wrong, rigged, or that they are not sustainable. (See graphs in 09/17/2010 weblog entry.) Few investors or pundits can clearly indentify the catalyst that will cause the whole thing to “turn around”.

Corporate Profits Recover

Time for a review of the basics of how equity prices are determined. Let’s start with the question, “How much would you pay for a security that promised to pay you $2500 per year, forever?” The answer for most people is that it would depend on the credibility of the institution making the promise, so let’s assume that probability of the promise being kept is very good. Most people would also need to know the rates of returns being offered by comparable investments.

So, for this example, let’s assume that comparably “safe” investments are currently paying 5% which is comparable to a price equal to 20 times the earnings or a 20 P/E ratio. So, most people would consider paying $50,000 for the security promising to pay $2,500 annually. (Based on current US Treasury Bond rates, buyers are paying more than $60,000 for 30 year bonds with a similar annual return.)

Next, how much would you pay for a security where the annual payment is likely to grow or increase over time? Let’s assume that the payment grows by only 3% per year—in 24 years the annual payment would have doubled to $5000. Since the “average” annual return over 24 years would be $3750, most people would be willing to pay 20 times $3750 or $75,000 for this security with a growing return. This would translate to a current 30 P/E ratio.

So, for a security with a stable return, a 20 P/E or price to earnings ratio is acceptable, and for one with a growing rate of return, a 30 P/E might be reasonable. The only reasons the P/E offered would be reduced is fear or belief (hence the risk) that the return or annual payment will be less or less certain in the future. The price of the “market” is clearly Earnings multiplied by Price/Earnings Ratio (P/E). The lower the P/E Ratio, the higher the perceived risk.

During Phase I, both Earnings and P/E Ratios (based on future earnings) fall, causing dramatic market declines. Typically, during the first stage of recovery, Corporate Earnings improve—as has been the case in this recovery. But during Phase II: Skepticism, even though earnings have improved, P/E ratios have not yet risen. Historically, the big market moves have been when earnings become stable (steady gradual growth) and P/E ratios expand dramatically. This will indentify the move to Phase III: Optimism. Essentially the P/E Ratio is a measure of Investor Sentiment.

The problem with trying to predict market movements is that one must predict or “guess”: Average Annual Earnings, Growth Rate and Relative Certainty (Risk). Then the P/E must be determined based on prices for “comparable” investments. When interest rates are low, then P/E Ratios for stocks tend to be higher. Finally, in order to predict market movements one must predict or “guess” likely changes in Sentiment which indicates how others (the market) have processed the same data.

As I wrote last month, “It seems that we are in a bubble of pessimism.” Without a doubt, there are many legitimate reasons for pessimism, but history teaches us that things will get better. As Jeremy Siegel, Wharton Professor and Author has written: “Over the past 200 years, we’ve gone through a Civil War, the Great Depression, two World Wars, and double-digit inflation in the 1970’s. There’s a long list of tragic events, but we always come back to the same trend of long-term stock returns.”

It seems likely that in the long run, Sentiment improves and P/E Ratio’s rise, creating an attractive rise in the market and a move to Phase III: Optimism. When it will happen is unknown. For those who have a long term perspective of 5 years or more—be prudent but start to get ready. “If you wait for optimism, you missed it.” And, “If you wait till you see the Robins, Spring has already arrived.”

In other words, markets will continue to fluctuate, and while one must always consider unknowable geo-political or natural disaster risks, the probability that markets will be significantly UP three to five years from now is significantly higher than the probability that they will be down.

Our economy may be slowing but it is very unlikely that we are making a U turn. Corporate profits may fail to meet analyst’s expectations, but the trend is still likely to be UP. The best assets to own during a time when corporate profits and sentiment improve are stocks.

Market recoveries are never a straight line up, and at each dip, fear will return. (Remember that September and October tend to be very volatile.) Chicken Little types will yell “Double Dip” and declare bizarre warnings of things like the “Death Cross” and the “Hindenburg Omen”. The media uses this hyperbole to entertain—not to inform.

While we are clearly not there yet, and may be moving slower than hoped, as corporations hoard cash and consumers pay off debts, we are clearly also increasing our potential for growth. Be patient, those delayed rewards may be better than we expect. We are in the middle of the Skepticism Phase, but Optimism is coming, sooner than later.

I suggest that you review my January 31, 2009 posting: “Early is on time, on time is late, and late is unacceptable”. Since then, the S&P500 is up about 5%, corresponding to a 7.5% annualized return.

Corporate Profits Show "Recovery in Aggregate"

2010-09-17T07:39:00.000-07:00

Anemic Real Estate is affecting and is affected by Sentiment

Unemployment, like housing is affected by and is affecting Sentiment

Corporate Profits Show "Recovery in Aggregate"

Along with sentiment regarding the future, corporate profits are fundamental in determining the value of corporate equities.

Are we there yet?

2010-08-14T10:12:00.000-07:00

Human beings are not known for being patient. According to the internet Wikipedia article on Patience, we “are inclined to discount future rewards—the present value of delayed rewards is viewed as less than the value of immediate rewards.” On a long trip, our children want to know, “Are we there yet?” and “How much longer?” will it be until the destination is reached.

Our economy is clearly “recovering” from a financial crisis, but we have not yet “recovered”. The trip is not over, and we are not there yet. During the initial stage of the recovery, it appeared that we were making rapid progress and we hoped that our destination was in site. Over the past few months, it has become clear we are moving slower than we thought and that the journey back to “recovered” will be longer than we hoped.

Data indicates that we have now had 15 straight months of unemployment at 9 percent or higher, 12 months at the current 9.5 percent level or higher. Of the more than 10 million currently unemployed, almost half have been unemployed for more than 6 months. To some, the most impatient and the most pessimistic, it seems that we are moving so slow, that it will take forever to reach our destination of being “recovered” and comfortable. These folks are not only worried about the present headwinds of unemployment and a weak housing market—they are also worried about future headwinds, like higher taxes and bigger government.

It seems that we are in a bubble of pessimism. We can be so focused on the fact that the trip is longer than we hoped, that we fail to recognize that we are still moving toward the destination. As I have written, markets value stocks based on future earnings. Future earnings are unknown, so they are estimated based on present earnings (E) and investor sentiment regarding the future, sometimes measured by the price/earnings ratio (P/E).

Many still estimate that earnings for the S&P500 will reach 79 for 2010. With a P/E of 15, this would result in an S&P500 of 1185 or almost a 10% increase above the 8/13/2010 close. (The estimates for S&P500 earnings vary from 70 to 87 and estimated P/E ratios range from 12 to 18, for a range for the S&P500 from 840 to 1500—now that’s uncertainty!)

In addition, when we finally reach “recovery” and return to the S&P500 level reached nearly three years ago in 2007, the market will have risen by 45% from it’s present level !

Corporate profits are clearly recovering. Earnings reported in July have indicated that corporate earnings continue to exceed expectations. Our excessive pessimism tends to discount the importance of these higher earnings with an attitude that the improvement is only temporary.

My prediction is: corporate profits are on the road to recovery. This road may not be straight and it may be uphill, but it’s general direction is toward improvement. We may be slowing but it is very unlikely that we are making a U turn. Corporate profits may fail to meet analyst’s expectations, but the trend is still likely to be UP. The best assets to own during a time when corporate profits improve are stocks.

While we are clearly not there yet, and may be moving slower than hoped, as corporations hoard cash and consumers pay off debts, we are clearly also increasing our potential for growth. Be patient, those delayed rewards may be better than we expect.

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.

Changes in Employment DO NOT predict Future

2010-07-02T13:31:00.000-07:00

Market action has been dominated by “traders” who bid up prices and sell quickly. In addition to the traders who sell quickly, driving prices downward, this downward momentum sometimes causes many ill informed individual and institutional “investors” to panic and add to the downward momentum by “getting out before it gets worse”. In addition, many traders not only sell quickly; some also make big “bets” that the market will decline. (I think sometimes these traders actually enjoy and profit from extreme volatility, changing their strategy after they witness those “ill informed individual and institutional investors” finally throwing in the towel.)

I never recommend significant adjustments to a sound long term investment strategy unless we see some indication that markets will fall far enough and stay low long enough to justify the risk of missing the gains when markets recover from excessive fear. At this time there does not appear to be any indication of a deep decline that will last a significantly long period of time. Continue to diligently monitor the situation, searching for any such indication.

I would not expect most investors to become macroeconomists, but there are a few good websites that they should visit from time to time: Conference Board—Publisher of Leading Indicators and Consumer Sentiment Data: http://www.conference-board.org/ ; ISM—Publisher of Purchasing Managers Indexes: http://www.ism.ws/ ; Association of American Railroads who publish rail traffic and other economic data: http://www.aar.org/newsandevents/railtimeindicators.aspx ; and Bloomberg.com’s page for the Baltic Dry Index http://www.bloomberg.com/apps/quote?ticker=BDIY:IND . Reviewing the information tells one to be very careful with hyperbole (hype) from the press.

A look at the Baltic Dry Index shows a drop in shipping rates in late May. This might indicate a reduction in global trade, but a look at it over a longer period of time indicates such short term fluctuations are normal and it appears the index is “on trend” to recover to past highs. A look at rail traffic: carloads for the week ending June 26, 2010 “up 11.4 percent compared with the same week in 2009” and intermodal traffic “up 20.5 percent from a year ago and down only 1.1 percent compared with 2008.” JPMorgan Global Manufacturing PMI (Purchasing Managers Index) at 55 for June—“growth remains solid overall and above long-run trend” and June ISM at 56.2—“New Orders, Production and Employment Growing, Supplier Deliveries Slower, Inventories Contracting. Leading Indexes for the US, China are Germany are all UP.

So what is it that so many are worried about? The economy does not appear to be creating jobs fast enough to satisfy some. In 2009, there were 53 million jobs lost and 48 million created. For employment to improve, more jobs need to be created than lost. Well, the latest information, today on July 2, 2010, indicates there were 83,000 net jobs created by private employers in June 2010 and unemployment fell from 9.7% to 9.5%. However at that rate, those nearly five million jobs lost in 2009 will take a very long time to replace.

The momentum of growth has clearly slowed, but most statistics indicate that growth is continuing. Many fear that with chronic long term high unemployment, the economy is doomed to slow growth, no growth or maybe even the terrible “double dip”. And, many do not like to hear that governments around the world may begin to reduce deficits and government payrolls, which many fear will contribute to economic slowing.

My comment regarding fears about reduced government spending: Priming the pump is wise and necessary, but it is only a temporary solution. Once the pump begins to function, continued priming to make the pump put out more and faster is wasteful and foolish. High unemployment is always a sad situation, but unemployment of 9.5% does not necessarily mean a decline in corporate profits and stock prices. The 90.5% of the workforce that are working may be productive enough and spending enough to make the economy quite healthy. Not as healthy as if unemployment were 5% but healthy nonetheless.

Probably the most important economic statistic that is seldom mentioned is the dramatic improvement in productivity that has occurred in the past year or so. It is not so much a bad economy that is keeping unemployment high. It is this improved productivity that is keeping unemployment high. Companies can produce and are producing significant profits with fewer employees. Many believe that the “new normal” for unemployment is much higher than in the past. So, slow increases in employment and continued high unemployment may not justify a reduction in stock prices.

Many still estimate that earnings for the S&P500 will reach 79 for 2010. With a P/E of 15, this would result in an S&P500 of 1185 or a 16% increase from the end of June level. (The estimates for S&P500 earnings vary from 70 to 87 and estimated P/E ratios range from 12 to 18, for a range for the S&P500 from 840 to 1500—now that’s uncertainty!)

The recent fears about a slowdown in Europe are probably what started this recent “panic”. Reality is that it probably will cause Europe to buy less from us. The offset of this is that the recent change in China’s currency rate policy will probably cause us to sell more to them. What we lose in Europe may be offset by what we gain from China.

It has been said that markets are only “right” five (5%) percent of the time…and they are “wrong” ninety-five (95%) percent of the time. In the short term--the markets express emotion; they measure corporate profits in the long term. My prediction is: corporate profits are on the road to recovery. This road may not be straight and it may be uphill, but it’s general direction is toward improvement. It is very unlikely that we are making a U turn. Corporate profits may fail to meet analyst’s expectations, but the trend is still likely to be UP. The best assets to own during a time when corporate profits improve are stocks.

Employment is not a leading indicator—corporations hire AFTER they are making profits—not before.

The most important thing for investors to consider is not what the S&P500 will be in 2010, but rather, what will it be in 2015. The important questions are: “If markets drop, are they likely to recover within 12-18 months?” and “Are we on track to achieve annualized returns of 8-12% over the next five years?” as well as “How should my portfolio be positioned to achieve my long term financial goals?”

When traders and gamblers are fearful and uncertain, predicting the “bottom” or the lowest point that markets reach is a futile exercise—it is unknowable. And, there are always risks regarding events that are unexpected or that are very unlikely, but possible. That is why the only money that should be invested now is that money that you do not need for at least five years—with a long term strategy, short term fluctuations based on market crowd “emotions” are really of no concern.

I never recommend significant adjustments to a sound long term investment strategy unless we see some indication that markets will fall far enough and stay low long enough to justify the risk of missing the gains when markets recover from excessive fear. At this time there does not appear to be any such indication.

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.

Fear of the Unknown

2010-06-07T08:44:00.000-07:00

The March-May quarter first appeared to be a period of growth when suddenly sentiment of professional traders, hedge funds, and institutional investors turned 180 degrees from very optimistic to very negative. This shift fed on itself, leading to the dramatic one month drop of 8.2% in the S&P500 and an 11.8% fall in the MSCI World Index. May produced the worst drop of the DOW JONES Index since 1940. The S&P500 drop was the worst since 1962.

The big question: What comes next?

I have written that “It is important for “investors” to weigh in the balance the opposing risks of being too conservative versus the risk of a possible short term decline.” and “Market action since August has been driven by trading rather than investing---Market action is dominated by “traders” who bid up prices and sell quickly.” as well as “There is still a tremendous amount of cash on the sidelines.” All of these statements still apply.

Nobody knows, with certainty, what markets will do in the short term. Short term movements tend to be based on emotion versus logic. Rather than a certainty that markets are likely to fall, there seems to be general feeling by traders of “let’s wait and see”. In other words this is a period of significant risk for short term investors and a time that requires patience and commitment for longer term investors.

Nothing illustrates this market “nervousness” and the markets moving from fear to greed and back to fear again, better than action during the first week of June. Based on comments from our President that employment was improving, the DOW rose 285 points Wednesday and Thursday, falling back by 323 points on Friday after it was reported that most of the employment “improvement” was temporary government census workers.

I never recommend significant adjustments to a sound long term investment strategy unless we see some indication that markets will fall far enough and stay low long enough to justify the risk of missing the gains when markets recover from excessive fear. At this time there does not appear to be any indication of a deep decline that will last a significantly long period of time. Continue to diligently monitor the situation, searching for any such indication.

On the other hand, there are significant indications of a very oversold market situation. Many estimate that earnings for the S&P500 will reach 79 for 2010. With a P/E of 15, this would result in an S&P500 of 1185 or an 8.8% increase from the end of May level. (The estimates for S&P500 earnings vary from 70 to 87 and estimated P/E ratios range from 12 to 18, for a range for the S&P500 from 840 to 1500—now that’s uncertainty!)

The most important thing for investors to consider is not what the S&P500 will be in 2010, but rather, what will it be in 2015. The important questions are: “If markets drop, are they likely to recover within 12-18 months?” and “Are we on track to achieve annualized returns of 8-12% over the next five years?” as well as “How should my portfolio be positioned to achieve my long term financial goals?”

A word about Europe..the “worldwide financial crisis” started in 2007-2008 as a result of a fear that high levels of debt would result in defaults and huge losses by lending institutions—leading to a decline in economic activity. This fear subsided in part because of an expansionary monetary and fiscal policy implemented by governments all over the world. Because of the unique structure of Europe’s monetary policy, it became unclear how Europe could sustain the expansionary fiscal policy of government deficits. And, almost simultaneously, because the policy worked so well in the US and China, fears surfaced that these governments might also move to a less expansionary policy in order to alleviate risks of inflation. This caused a nearly perfect storm of fear—not fear of the known, but fear of the unknown.

Is Europe going to reduce fiscal stimulus, perhaps even causing an economic slowdown as they cut government spending and deficits? Will this cause an economic slowdown everywhere, causing the dreaded “double dip”? Well, that is the question that is causing the fear and uncertainty.

First, will a reduction in deficit spending in Europe cause an economic slowdown? By itself, this is probable, but when it is considered that the Euro is likely to have fallen by 15-20%, it is not so probable. Consider that every enterprise in Europe is now 15-20% more competitive—this is a large off-setting stimulus.

Second, will a more competitive Europe mean less economic growth in the US and China? This is probable. On the other hand, with a more competitive Europe, selling to the US for lower prices, it is likely that the US will be able to sustain it’s expansionary monetary policy for a longer period.

When traders and gamblers are fearful and uncertain, predicting the “bottom” or the lowest point that markets reach is a futile exercise—it is unknowable.

Prudent portfolio management in periods like this is a bit like sailing a ship in the middle of the North Atlantic during a weather storm. It is seldom wise to return to port and abandon the long term plan of the voyage. It is wise however to be increasingly vigilant to ascertain if any adjustments to the course or rigging may be prudent…and increasingly vigilant for evidence of any new approaching storm.

I never recommend significant adjustments to a sound long term investment strategy unless we see some indication that markets will fall far enough and stay low long enough to justify the risk of missing the gains when markets recover from excessive fear. At this time there does not appear to be any indication of a deep decline that will last a significantly long period of time.

What comes next?

My best estimate at this time: (subject to change with changing conditions.) In the near term expect very high levels of uncertainty and therefore volatility. Be prepared for 2-3% changes in market levels---daily. Be prepared for short term declines in reaction to bad headlines. Longer term: (barring an unexpected geopolitical event) A) The global economy and corporate profits will rise, albeit at a slower rate than in previous expansions—Market prices will rise accordingly; B) The retirement of debt will be a drag on economic growth; C) Global commerce will increase; and D) Inflation, taxes and interest rates are ALL likely to rise. In my opinion, the best thing to own: a very diversified, income producing portfolio of worldwide stocks and intermediate term bonds issued by “solid” entities/companies that gain from such an environment—with “enough” cash to cover your short term needs.

I continue to advise a cautiously optimistic outlook, being alert and staying prepared for opportunities as well as risks. This means a diversified portfolio consistent with your long term goals and sufficient cash/income to insure that good quality investments do not need to be liquidated at low prices.

Considering that a 44% rise in the market would be required, to get back to the October 2007 “peak” levels, there is a lot of room for markets to rise—moving toward a “fully invested” status between now and September is probably advisable for long term investors with a normal risk tolerance. (Those with a lower tolerance for short term risk and market fluctuation are advised to hold a higher than normal cash level.)

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.

Options Expiration Week Anxiety and Uncertainty

2010-05-20T09:34:00.000-07:00

We have been hearing a lot about how “derivatives” have increased market volatility. A derivative is a financial instrument or security that can be traded, where the value is “derived” from another security. One of the oldest forms of derivatives is the stock option.

The “basic” stock option is a “right, but not an obligation to buy or sell a stock at a fixed price”. They can be used as a form of insurance, but in most cases they are used by gamblers to increase potential gains as well as potential losses.

One fundamental aspect of most common options is that they “expire” on a given date. In other words, they can become completely valueless on a given day. From the website www.cboe.com (Chicago Board Options Exchange) “The expiration date for equity options is the Saturday following the third Friday of the month. If the third Friday of the month is an Exchange holiday, the last trading day is the Thursday immediately preceding the holiday. After the option's expiration date, the equity option will cease to exist.”

During periods of relative market stability, options expiration does not appear to cause large changes in stock prices. But during periods of extreme fear or greed, it appears that markets sometimes move by large amounts during the week preceding the options expiration date for equity options in the USA. For example, in January and February of 2009, during a period of extreme fear, the S&P500 fell around 10% in the 7 day period preceding options expiration.

On May 12, 2010, the S&P500 closed at 1171. A 10% move down from there would result in an S&P500 level of 1053 or about the same as the 2010 low on February 8. An S&P500 level of 1053 would be a 13.5% “correction” from the 2010 high of 1217. Although such moves down are worrisome, they are not necessarily abnormal nor do they necessarily predict continued decline.

Markets move up because of greed and hope. Markets move down because of fear. In my last blog, I indicated that “As investors, we have always known that we have to co-exist with “gamblers” or traders who are always trying to make fast money by betting with each other.” It is clear that the gamblers or traders have been overcome by fear related to uncertainty. This uncertainty is related to Europe and potential changing of rules in Washington DC.

Markets in the short term are driven by fear and greed. Market movements are exaggerated by the actions of gamblers. It must be remembered that sovereign debt problems, like unemployment tend to be a lagging indicator, not a leading one. Investors know that markets fluctuate, but in the long run, stock markets return to the value determined by corporate profits. Few would argue that corporate profits are not in an upward trend. The debate is really about how fast they will increase. If and when you are confident of the trend, then use the exaggerated market movements caused by fear, greed and the foolish activities of gamblers to your advantage.

There is no way to predict when this current downdraft will reverse. But, you can already hear some of the gamblers beginning to speak about the markets reaching levels where they are comfortable “getting back in”.

Keep in mind that a falling Euro will benefit companies that produce in Europe. It will also cause products made in Europe to be cheaper for American consumers. Keep in mind that falling oil prices tend to stimulate the US economy. Not more than 2 months ago, the headlines were all about the belief that a falling US Dollar was bad. Now, with a stronger US Dollar, there is fear that economic activity will decline. When the headlines seem irrational—they and markets are usually driven by fear and fear in markets tend to create opportunities for buyers—not sellers.

If your money is invested for the long term—five years, ten years or more, and you have income or resources to support yourself in the near term, then stay invested. If you have excess resources, then low prices and fear are an invitation for you to profit—the last two weeks has produced a renewed list of opportunities that seem to become more attractive each day.

The days leading up to options expiration can be so much dominated by options induced volatility, it is seldom a good time to make decisions regarding a change of strategy or a decision to reallocate a larger amount of the portfolio to cash/fixed income. Investors should base their decisions on fundamental principles, not a fear of volatility. Volatility is a normal part of market action, particularly during periods of economic recovery.

Markets sometimes tend to act like a herd of cattle. Sometimes the herd moves toward its expected destination rationally—sometimes it just stampedes off in one direction or another and only stops when the members of the herd get tired.

If you are a gambler, I can’t help you since I do not provide advice or education to gamblers.

If you are an investor, it is probably wise to stay the course until we can see more clearly if the economic environment is truly changing.

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. 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.

Chicken Little Should Have Had a Better Memory?

2010-05-08T12:19:00.000-07:00

We all remember the fable about Chicken Little who when hit on the head by a falling acorn, decided that the sky was falling—instigating a panic in the community as everyone tried to save themselves from the impending doom. Who would have thought that a possible default in a country the size of Greece would have set off the events of the past week? Particularly since the problems in Greece have been in the news for months.

But, this is how markets work. In the short term, market values are based on perceptions of the future, or in other words, pure psychology. Should we have seen this coming and sold investments? You can’t shoot your herd of cattle just because there is a risk of a stampede! These types of panics can happen at any time.

As investors, we have always known that we have to co-exist with “gamblers” or traders who are always trying to make fast money by betting with each other. Believe it or not, they really do provide a benefit in the form of liquidity and increased market volume. The price we and they pay for this liquidity however is in the form of volatility. What is new is the fact that these gamblers are now armed with increasingly powerful computers driven by computer programs or algorithms designed to exploit minute market movements and to “protect” the gamblers from market falls. If and when these programs all decide, at the same time, that the market is going in the “wrong” direction, they can create awe inspiring market movements like we saw this week.

In response to market volatility in 1987 caused by computer program trading and so called automatic sell programs called “portfolio insurance” the NYSE instituted “circuit breakers” or mandatory pauses in trading. These rules were revised in 1998. The current rules are shown on the website www.nyse.com. Interestingly, no trading halts are set to occur between 2:30PM and 4:00PM ET! It appears that perhaps the new “program trading” algorithms have adapted to this as the “big event” this week occurred after 2:30PM! We may never know exactly what happened, but in an auction market like the stock market—when there are no buyers, prices can get very low, very fast. Especially when computers, not humans are carrying out the bulk of the buys and sells. And, especially with increased potential volume as the result of a dramatically increased activity in derivatives and options. Most likely computer programs began selling and created a vicious cycle as stop loss orders to protect against loss kicked in, creating a tsunami of sell orders with no buy orders until prices fell substantially.

Back to the credit crisis concerns about Greece that seemed to light the fuse this week. We have seen this type of thing before. In 1997 we had the Asian Credit Crisis, followed a year later by the Russia’s debt default in 1998. Then in 2001, Argentina defaulted on $132 Billion in sovereign debt—about the same that is at risk in Greece. (Greece’s and Argentina’s economies are about the same. Greece’s economy is only 0.3% of the world’s GDP.)

Let’s put things in a bit of perspective. In early October 1997 the Dow was at 8178. When the Asian Crisis created a reaction, the Dow fell 12.5% to 7161. Eight months later, the Dow had risen 30% to 9328. Reaction to the Russian default in August 1998 caused the Dow to drop 16% to 7827, still 9% higher than the low after the Asian Crisis. The Dow then rose to 11772 by January 2000, falling to 7528 in October 2002. By October 2007, the Dow had risen to 14066. In 10 years from October 1997 to October 2007, the Dow rose from 8178 to 14066, thru three credit crises and a terrible bear market in 2000-2003.

So here we are again with a credit crisis, where fear of contagion causes a bit of panic. The Dow falls 7.4% in days from 11205 on April 26 to 10380 on May 7. Is it over? Probably not yet. The Dow closed at 10325 on the last day of February. Many gamblers may not feel that it is safe to get back into the water until we see a classic 10% “correction”. So, many are probably looking for the Dow to fall at least another 2.3% to 10084. (The Dow was 9908 on 2/8/2010.) Nobody knows for sure when it will change direction. It will change only when the perception of the future changes.

Economic cycles have always more or less been driven by debt. Increased borrowing tends to increase economic growth until the borrowing reaches a point where debtors cannot service it. Then there is a period where debts are restricted or written off and losses are recognized. Decreased borrowing tends to curtail growth.

One big fear is that, even though the US seems to be in a strong economic recovery, that problems in Europe will curtail economic recovery there. And, with a weak Europe, China’s export machine sputters, and the outlook for continued growth in the US is diminished. Another fear is that terrorism is on the rise. Another fear is that governments around the world seem to be taking on too much debt.

It has been said that the most dangerous words related to predicting the future of economies and markets are: “But this time it is different”

The best advice is always to study history and learn from it. Markets in the short term are driven by fear and greed. Market movements are exaggerated by the actions of gamblers. It must be remembered that sovereign debt problems, like unemployment tend to be a lagging indicator, not a leading one. Investors know that markets fluctuate but in the long run, stock markets return to the value determined by corporate profits. Few would argue that corporate profits are not in an upward trend. The debate is really about how fast they will increase. If and when you are confident of the trend, then use the exaggerated market movements caused by fear, greed and the foolish activities of gamblers to your advantage.

If your money is invested for the long term—five years, ten years or more, and you have income or resources to support yourself in the near term, then stay invested. If you have excess resources, then low prices and fear are an invitation for you to profit—the last week has produced a renewed list of opportunities.

If you are a gambler, I can’t help you since I do not provide advice or education to gamblers.

And if you are an investor, when you hear the cries of Chicken Little, tell him he should have a better memory.

This post is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. 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.

Should you be afraid of September and October?

2009-09-10T06:19:00.000-07:00

Invariably, the media will begin to write stories about how September and October have been historically bad months for the stock market. Given market declines in September and October of 2008; along with the human tendency to overweight recent data; and the recent market gains: there is likely to be a lot of anxiety this year.

It is true that on AVERAGE, returns during September have been negative. October has not been a particularly good month either, on AVERAGE, but contrary to popular myth, September on AVERAGE has been worse than October.

But the term “on AVERAGE” fails to inform that returns during September and October have been positive in many years. Negative returns in some years tend to overshadow the smaller positive returns in other years.

Using data for the last 20 years, returns during 50% of the September periods have been negative. For October, the percentage is a low 30%. Using data for the last 40 years, there was a 50% chance of a decline in September and a 38% chance in October. During the period from 1897-2007, the DOW has fallen in September 59% of the time, and 41% in October. During September periods following periods of a rising market (like this year) returns have been negative 82% of the time. (With a 1.73% decline on AVERAGE.)

I think the important take away is that you should not be afraid of the calendar. Markets move because of fundamentals and sentiment. Investing is about looking forward, not backward. Markets may tend to decline in September because of fears that corporate earnings in the October “Earnings Season” may fail to meet expectations, but it is unlikely that they will fall just because markets have fallen in previous Septembers.

The good news for long term investors is that since 1960, there has been a “pattern” where markets “typically” rise in the September-December period, with a rally late in the year more than compensating for a small decline in September/October.

There are many that are waiting for a “correction” because they feel we have come too far, too fast. On the other hand, we are still 34% below the recent peak in October 2007 and markets would have to rise another 51% to reach that peak. Fundamentals and sentiment are both improving and there is still a lot of cash waiting to come into the market.

So, except for day traders trying to profit from short term market movements, prudent long term investors would probably be wise to begin putting excess cash to work according to an organized plan and entry strategy designed to allow them to reach their long term goals.

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. 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.

Déjà vu? Be Cautious, Patient and Look For Opportunity

2009-08-22T11:17:00.000-07:00

We have seen bull markets coming out of a recession continuing into July and August before.

In 1933, markets had a huge rally of more than 100% (doubling) from February, ending on July 17, with an 18% correction following in short order. (See previous blog, Perspective from 1933.)

In 1975, a rally of 53% occurred starting in October 1974, with nearly a 14% correction in August and September.

In 2003, markets rose from March to July by more than 25%, with a small 5% correction.

In all three cases, markets returned to the previous high within 5 months. So in each case, the correction was a “buying opportunity”.

So far this year, we’ve seen a rally of around 50% right up to “options expiration” week in August. The S&P500 closed on 8/21/09 at 1026. A 5% correction (2003 level) would take us to 975. A 14% correction (1975 level) would take the S&P 500 to 882. This is not 1933, 2003 nor 1975, however, I have said before that this market “feels” like the 1970’s.

Nobody can predict the exact timing or extent of market movements, but history does teach us that markets fluctuate and tend to take a “rest” and “correct” after big gains that occur over short periods.

For long term investors already invested, these corrections may not be worth the transaction costs of making big changes, but for those with cash on the sidelines, they present an opportunity.

The recent moves have clearly been the result of cash piling into the market. I wrote in July, “But, when the majority do believe (that the worst is over), the tsunami of cash coming into the market may result in impressive gains.” Impressive indeed! This new cash came in because so many companies “beat analyst’s estimates”. So July and early August will probably be deemed the “relief” rally with greed and fear of missing out overwhelming those that fear loss.

Now the market will begin to ruminate about what earnings will be for the next few quarters. If no bad news comes out, markets may continue to rise. Momentum is important. Keep in mind, we are still 21% below August 28, 2008. We would need another 26% rise to reach that 1300 level. But, many will begin to fret that we have come too far too fast. History teaches us that there will probably (but not certainly) be a “buying opportunity” soon.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation. 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.

Buy and Hold--Is There a Better Way?

2009-08-20T08:37:00.000-07:00

Modern Portfolio Theory—Is it really so Modern?

Fifty years ago, in 1959, Harry Markowitz proposed that investors expect to be compensated for risk and that an infinite number of “efficient” portfolios exist along a curve called the “efficient frontier”. The formula used to create this “efficient frontier” is known as mean variance optimization or MVO. It is the basis for what has become known as Modern Portfolio Theory. Markowitz and William Sharpe, the inventor of the Capital Asset Pricing Model shared a Nobel Prize in 1990 for their work.

This highly theoretical and academic work was widely adopted by the investment community. The “method” became: Choose a risk level you are comfortable with and then build a portfolio of diversified investments that match the efficient frontier and you can predict your probable or expected return. Wait long enough and your return would most surely be the magic number predicted by the efficient frontier curve for your level of risk. Maybe….

The efficient frontier is defined by three variables: standard deviation, correlation coefficient/s, and return. The basis of MPT is that investors are rational and that they will always seek out the most efficient portfolio—the highest return for their acceptable risk level.

After Markowitz came another academic, a Eugene Fama who postulated that markets are efficient with all participants acting rationally with complete information and therefore securities are accurately priced most of the time. This was expanded by Burton Malkiel who wrote the book, The Random Walk Down Wall Street. This led to what is now known as the Efficient Market Hypothesis or EMH.

All this academic theory and hypotheses essentially got wrapped up into one big concept: “Buy and Hold”. Hire a professional to build an “efficient” portfolio and keep and eye on it—wait a sufficient period of time and make money! Maybe not…

Rational Expectations versus Rational Beliefs

Most economic theory is based on Rational Expectations. In other words people act with their best guess of the future (the optimal forecast) that uses all available information. It somehow assumes that everyone has the same information and therefore everybody’s “rational” best guess is the same. If they act differently, then they are irrational. This has always seemed a little silly to me, but it seemed to help explain many things.

A Stanford University Professor named Mordecai Kurz began to question the concept of Rational Expectations, and became known as the father of Rational Beliefs Theory. It is a subtle difference, but essentially it says that people will act according to their “beliefs” and that many different beliefs exist at the same time. As long as people act according to their beliefs, they are acting rationally.

Kurz essentially explains how markets can be crazy without having to refute that people have similar access to the same information. It does not require us to assume that people are crazy. Different people have different beliefs while having the same information. People change their beliefs when proven wrong either by facts or sometimes by herd behavior. It essentially states that people change their minds.

Post Modern Portfolio Theory and Downside Risk Optimization

Post Modern Portfolio Theory assumes that people seek to avoid loss more than they seek large gains. (Fear of loss is exponential and there is a leakage of utility on the upside.) It also assumes that most investors have a minimum acceptable return or MAR. Returns below the MAR are what investors fear much more than mere “fluctuation”. Modern Portfolio Theory has been developed and promoted by Frank Sortino of the Pension Research Institute. He developed a measure of risk called the Sortino Ratio.

Dynamic Asset Allocation vs. Buy and Hold

While MPT leads to “static” Buy and Hold portfolios, PMPT and the Rational Beliefs Theory assumes that the world is a changing place—concluding that a “Dynamic Asset Allocation” is more appropriate. Dynamic Asset Allocation requires a changing portfolio. Changes will be based on exploiting inefficiencies in markets and adapting the portfolio to the current situation as well as possible future situations. The current situation is created by varying beliefs regarding the future held by all the different market participants. In other words, the optimum portfolio is that that which addresses the owner’s MAR and belief/s regarding the future--thereby optimizing downside risk. It is also based on our ability to have some idea how other investors beliefs are correlated and how they may change in the future.

Reasonably Reliable Leading Indicators (RRLI’s)

I have always assumed that technical analysis was sort of like the “reading of the bones” by shaman and witch doctors---looking for meaning in meaningless patterns. However, since human nature drives markets, and human nature tends to be relatively constant, we may be able to ascertain present investor beliefs based on market behavior—to a degree. These present market beliefs may be part of a pattern that has occurred in the past, and certain market behavior may signal a future change in how investors’ beliefs will be correlated in the future. Some indicators are considered technical and others may actually be more fundamental where they signal a situation that will actually cause a change in markets.

None of these “indicators” are perfect. They may be predictive only 60-70% of the time. One thing we know, when many indicators point to the same conclusion, the probability of that conclusion being correct increases significantly. They provide a useful set of tools when the goal is a Dynamic Asset Allocation. Remember that Dynamic Asset Allocation is not the same thing as market timing—we are seeking return with downside risk considered and not just the highest possible return. We may avoid a possible profit opportunity if the risk of loss is small but the possible size of the loss is too large for us to tolerate.

Here is a limited list of some relatively powerful Reasonably Reliable Leading Indictors: A) The US Treasury Yield Curve; B) The Corporate to Government Bond Yield Spread; C) The occurrence of Black and Golden Crosses, and D) The Relative Strength Index.

The US Treasury Yield Curve or the difference in rates for short term vs. long term is a very useful indicator. When it goes inverted it is a strong indicator of a down market coming. When it has a steep upward slope, it is a reasonably strong bull market indicator. It becomes more accurate the longer it stays in one phase.

The spread or difference between “riskless” government bonds and “risky” corporate bonds tends to correlate with markets being euphoric or risk averse. Inappropriate pricing of risk is a reasonably strong indication that beliefs are highly correlated and likely to change. Euphoria and Emotional Depression are never permanent. They usually represent opportunity for a Dynamic Asset Allocation strategy. As Warren Buffet has said, “buy and be greedy when others are fearful; sell and be fearful when others are greedy”.

Black and Golden Crosses are bear and bull market predictors. The “cross” occurs when the 50 day moving average crosses the 200 day moving average. When the short term average moves higher than the long term, it is a bullish indicator. According to research from one large brokerage, “The S&P500 has had 15 Golden Crosses associated with NBER recessions—these signals on average led to a 19.2% gain one year later”. Golden Crosses tend to be more predictive during a recession. Black Crosses tend to be more predictive after a bull market has become a bit long in the tooth.

The Relative Strength Index is one of many created by J. Welles Wilder and published in his book: New Concepts in Technical Trading Systems in 1978. It can be as complicated as the user desires, but most people use a smoothing factor/period of 14. Most users believe that around 30 is a strong buy signal and 70 is a strong sell signal. The RSI may be useful when entering markets or determining the best time to adjust a dynamic asset allocation.

WS Wealth Managers Inc. uses the above mentioned RRLI’s along with others not mentioned when making judgments about changing asset allocations.

Remember that RRLI’s are never perfect—they increase the probability of being correct, but do not guarantee being correct. That is why we call them “reasonably” reliable. A diversified portfolio made up of quality assets that are somewhat negatively correlated is always more important than attempting to predict the short term future behavior of market participants.

The argument whether markets are random and therefore completely unpredictable, or just chaotic where they appear to be random but are in fact orderly is the same debate that is going on regarding Brownian Motion, Chaos Theory and Fractals. Now that is truly a scientific technical discussion and a topic for another day.

This paper is for educational purposes and for the sake of discussion. It is not a complete discussion regarding portfolio management. It is not a sales presentation and not a recommendation. 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 and fundamental analysis.

The Market is from Missouri

2009-07-18T12:50:00.000-07:00

In February I wrote that markets can go up a lot after the inauguration of a new US President, in the midst of a recession. In May I wrote that Hope and Worry would engage in a classic conflict resulting in market volatility with a possible “correction” after hitting a peak. From the March 9 “bottom” the S&P500 rose 40% until falling 7% in June, and rising back 7% to 940 on July 17. So, far, we have witnessed an almost classic panic followed by a euphoric, “the worst must be over” and “we don’t want to miss out” 40% relief rally followed by normal profit taking and uncertainty.

Now, we are in the middle of “earning season” and markets are moved by reported profits; how those profits compare to previous estimates by analysts, and “guidance” from the reporting companies. If companies report good earnings but the CEO is pessimistic about the future, the stock probably goes down. If companies report bad earnings, but beat “expectations” the stock may go up. What in essence is happening is that buyers are waiting for what they believe is evidence of profits in the future—“show me the money”.

There is no doubt that the economy is still a mess. Harley Davidson reported a 30% year over year decline in shipments. GE reported revenues were down 17%. The Fed reports they are concerned about labor markets and increased their unemployment estimates. They indicated that banks could foresee substantial losses in loan portfolios. They described the recovery and current situation as “fragile”. Commercial real estate is in the process of being revalued and recapitalized. Many fear that the pending recovery will be ”jobless” with growing GDP but high unemployment. Citizens are becoming impatient and the new President’s approval rating is falling.

So why does all this bad economic news not result in another leg down for the market, beyond the 7% we recently experienced? Remember that market prices for stocks are driven by expected future profits as well as the willingness of buyers to move out of cash and cash equivalents. As of May 31, 2009, cash/cash equivalents held by individuals and institutions totaled around $7.9 TRILLION—almost enough to buy the entire market value of all 500 companies in the S&P500. If we return to historical norms, nearly $4 TRILLION of cash is waiting to go back into the market. Much of this cash is what I refer to as “anxious” because short term interest rates are so low and people are afraid that markets will “take off” and leave them behind. For most investors, especially mutual fund and pension fund managers, the only thing worse than suffering a decline is not making it up--missing out on the recovery.

So if people from Missouri are skeptical and want to be shown real facts before they believe, the market now has the same attitude. Investors need to be “shown” that the companies are making profits and that future profits will be higher before they will believe that markets will go up. But, when the majority do believe, the tsunami of cash coming into the market may result in impressive gains. The difficult part will be figuring out just how much “proof” the majority will need to make them “believe” that future profits will be higher. This proof will come in the midst of continuing bad news about the present and near future state of the economy. What do they need to be “shown” for them to support their beliefs? One key may be related to improving productivity. There is growing evidence that productivity is increasing dramatically and will show up in corporate profits significantly before the employment picture improves.

Hope and Worry are likely to continue their battle. The Worry crowd will probably drive the market down periodically because of bad news. But investors are generally an optimistic group and those with a cautious but hopeful long term view are likely to be rewarded. We believe the current situation is “yellow” for the near to medium term, but “green” for the long term. Solid companies that have “staying power” with little debt, growing productivity, good products, and reasonable present earnings represent good opportunity and value.

This commentary and information is provided for the benefit of clients and should not be considered a sales presentation.

See http://www.waynestrout.com/ for more complete info: Investment advisory services are offered by WS Wealth Managers, Inc., an investment adviser registered with the Commonwealth of Pennsylvania and the State of Maryland. Wayne Strout is an Investment Adviser Representative with WS Wealth Managers Inc. in addition to serving as Chief Investment Officer of the firm. Scott Sebring is an Investment Adviser Representative and Vice President. Wayne Strout and Scott Sebring, dba WS Wealth Managers. Securities offered thru Glen Eagle Advisors LLC, Member of FINRA And SIPC, with clearing thru Pershing LLC, Division of Bank of New York Mellon Corporation, also Member of FINRA and SIPC. FOLIO Advisor program is available through FOLIOfn Investments Inc. a Member of FINRA and SIPC. WS Wealth Managers Inc. is not affiliated with Glen Eagle Advisors LLC, Pershing LLC or FOLIOfn Investments Inc..

On Economic Forecasts..Chance Favors a Prepared Mind

2009-05-26T07:30:00.000-07:00

Quote from speech by Ben Bernanke at Boston College Commencement 5/22/09:

“As an economist and policymaker, I have plenty of experience in trying to foretell the future, because policy decisions inevitably involve projections of how alternative policy choices will influence the future course of the economy. The Federal Reserve, therefore, devotes substantial resources to economic forecasting. Likewise, individual investors and businesses have strong financial incentives to try to anticipate how the economy will evolve. With so much at stake, you will not be surprised to know that, over the years, many very smart people have applied the most sophisticated statistical and modeling tools available to try to better divine the economic future. But the results, unfortunately, have more often than not been underwhelming. Like weather forecasters, economic forecasters must deal with a system that is extraordinarily complex, that is subject to random shocks, and about which our data and understanding will always be imperfect."

"In some ways, predicting the economy is even more difficult than forecasting the weather, because an economy is not made up of molecules whose behavior is subject to the laws of physics, but rather of human beings who are themselves thinking about the future and whose behavior may be influenced by the forecasts that they or others make. To be sure, historical relationships and regularities can help economists, as well as weather forecasters, gain some insight into the future, but these must be used with considerable caution and healthy skepticism.”

“In planning our own individual lives, we all have a strong psychological need to believe that we can control, or at least anticipate, much of what will happen to us. But the social and physical environments in which we live, and indeed, we ourselves, are complex systems, if you will, subject to diverse and unforeseen influences. Scientists and mathematicians have discussed the so-called butterfly effect, which holds that, in a sufficiently complex system, a small cause--the flapping of a butterfly's wings in Brazil--might conceivably have a disproportionately large effect--a typhoon in the Pacific. All this is to put a scientific gloss on what you probably know from everyday life or from reading good literature: Life is much less predictable than we would wish. As John Lennon once said, "Life is what happens to you while you are busy making other plans."

"Our lack of control over what happens to us might be grounds for an attitude of resignation or fatalism, but I would urge you to take a very different lesson. You may have limited control over the challenges and opportunities you will face, or the good fortune and trials that you will experience. You have considerably more control, however, over how well prepared and open you are, personally and professionally, to make the most of the opportunities that life provides you. Any time that you challenge yourself to undertake something worthwhile but difficult, a little out of your comfort zone--or any time that you put yourself in a position that challenges your preconceived sense of your own limits--you increase your capacity to make the most of the unexpected opportunities with which you will inevitably be presented. Or, to borrow another aphorism, this one from Louis Pasteur: "Chance favors the prepared mind."”

Complete speech available:

http://www.federalreserve.gov/newsevents/speech/bernanke20090522a.htm

At WS Wealth Managers, we always tell our clients that Preparation is more important than Predictions which is another way of saying what Louis Pasteur said: “Chance favors a prepared mind”. Our view is that predicting the short term micro or macro economic future is like predicting the weather—we can only speak in probabilities. On the other hand, predicting what will happen can be done with much more precision than predicting when it will happen. (Assuming the predictor is intelligent and informed.) We can predict that Summer follows Winter. We know that Winter nor Summer do not go on forever. Being prepared is all about knowing what will happen—knowing that when it happens, you will be prepared to take a certain action that benefits you.

Hope vs Worry

2009-05-16T10:01:00.000-07:00

In February I wrote: “During periods of high volatility, and even in the middle of very tough economic times, markets can go up a lot.” This continues to be a true and important statement. Since the March 9 “bottom” stocks are up a lot. Is it time to throw caution to the wind? I think not.

Markets are created by buyers who have hope and sellers who have worry. Times of change are characterized by the tension of two competing fears: The Fear of Loss vs. the Fear of Missing Out.

Markets in the short term are driven by these emotions and sentiment. Hence, logic is almost useless as a predictive tool in the short run. In the long term however, markets are priced by the profitability of companies, which is driven by economic activity and increases in productivity over the long run. Logic can be very useful as a predictive tool in the long run.

From it’s peak of nearly $65 trillion in 2007, World Stock Market Capitalization fell below $30 trillion in March 2009. This type of decline has no explanation other than a global panic driven by a level of emotion (fear) and a fall in housing prices that I have not seen in my lifetime. Since this “bottom” in March, it has risen dramatically. In April alone, it rose $4.2 trillion. The only logical explanation is the recent rally is simply a realization that the previous decline was overdone.

You will hear the “worry” crowd pontificating that markets cannot recover until the economy improves. There are many signs that the world economy is still in a great deal of trouble. Unemployment is rising. House prices may fall further. People are spending less. The “hope” crowd however will point out that there are many “green shoots” or signs that things are on the mend: Consumer Sentiment is up; Housing has never been so affordable; Governments worldwide are proactive and are implementing unprecedented pro-growth initiatives; There is a great deal of cash sitting on the sidelines, earning little interest income and poised to enter the stock market. Both crowds are correct. But, most importantly, markets tend to turn upward ahead of the economy.

Within the “worry” crowd is a group who fear that our best times are behind us. They not only fear another decline in the short term but also a long term reduction in enterprise profitability and hence value. Within the “hope” crowd is a group that figures the worst is over and that good times will soon return. Both groups are probably incorrect.

The point here is that good times will return. The unknown is only really how soon and how fast. World stock markets were probably overvalued at $65 trillion in 2007. (Knowing what we now know about excess borrowing and debt.) They were undoubtedly undervalued at $30 trillion in 2009. A case can be made that their “fair” value is between $40-50 trillion. Markets therefore have room to rise. But, their rise is likely to be a roller coaster ride of ups and downs: Hope vs. Worry.

So, investors with a long term outlook should stay invested with a cautious outlook and cash should be deployed cautiously. Continued recession and a recovery with inflation are both very possible outcomes. What you invest in will be very important. Good advice has never been more valuable.

Perspective from 1933

2009-02-28T10:35:00.000-08:00

February 2009 closes with a monthly decline in the S&P500 of 11%. It fell from 825 to 735. Headlines are “The Worst February Market Drop Since 1933!” (The S&P500 fell 18.1% in February 1933.) Wow. I guess such sensationalism sells newspapers and TV advertising, but for investors:

Does this mean ANYTHING? Let’s put it in perspective… (You will probably not read these facts in the newspaper or hear it on TV.)

In March 1933, the S&P500 rose 3.87%. In April 1933, it rose 42.87%. In May 1933 it rose 16.46%. And in June 1933, it rose 13.50%. From the end of February 1933 to the end of June 1933, the S&P500 rose 196%. That’s almost double! If history repeated with the same percentage increase, the S&P500 would rise from 735 to 1440!

Another interesting tidbit: The Dow Jones Industrial Average rose from 53.84 to 62.10 or UP 15.34% on March 15, 1933. This continues to be largest one day rise in history—in the midst of the worst depression in history. (The Dow is up 131 times to 7062 as of 2/27/09.)

Nobody, including me, is predicting such a rise, but the facts do tend to put things in perspective. During periods of high volatility, and even in the middle of very tough economic times, markets can go up a lot.

When comparing now to 1933, let’s look back to some highlights:

Nazi leader Adolf Hitler was appointed Chancellor of Germany in January. (Not exactly a bullish sign.) An attempted assignation of President-elect Franklin Roosevelt occurred in February—He was inaugurated in March and gave his “The only thing we have to fear is fear itself” speech. Also in March, President Roosevelt declared a “bank holiday” closing all US banks for one week. 4000 banks failed in 1933, on top of 5700 banks that failed the previous four years. 14 million Americans were unemployed—25% of the workforce. The legislative climate moved from conservative to liberal with lots of government spending and programs. Here is a quote from the newly elected President Roosevelt:

“Throughout the nation, men and women, forgotten in the political philosophy of the Government, look to us here for guidance and for more equitable opportunity to share in the distribution of national wealth… I pledge myself to a new deal for the American people. This is more than a political campaign. It is a call to arms.”

1933 was definitely a scary time. Nobody was then predicting an immediate end of decline. While the news today sounds a little bit similar, few would argue that the situation is as dire now. But, even in the middle of those terrible times in 1933, the stock market almost doubled in value during March thru June. When comparing the present to the past, it is important to put things in perspective.

Nobody can predict what the market will do in March, April, May or June 2009. J.P. Morgan stated the only true prediction, when asked to predict the stock market: “It will fluctuate”.

This commentary and information is provided for the benefit of clients and should not be considered a sales presentation.

See http://www.waynestrout.com/ for more complete info: Investment advisory services are offered by WS Wealth Managers, Inc., an investment adviser registered with the SEC. Wayne Strout is an Investment Adviser Representative with WS Wealth Managers Inc. in addition to serving as President/CEO and Chief Compliance Officer of the firm. Scott Sebring is an Investment Adviser Representative and Vice President. WS Wealth Managers Inc. is not affiliated with Glen Eagle Advisors LLC or Pershing LLC. Wayne Strout and Scott Sebring, dba WS Wealth Managers. Securities offered thru Glen Eagle Advisors LLC, Member of FINRA And SIPC, with clearing thru Pershing LLC, Division of Bank of New York Mellon Corporation, also Member of FINRA and SIPC.

Three Important Hidden Risks to Consider

2009-02-21T13:57:00.000-08:00

So far in February we have a 6.7% decline in the S&P500. We are near the November 2008 low and down nearly 50% from the peak in October 2007. Our new President’s stimulus package, along with mortgage assistance to hopefully stabilize the housing market, and a credible promise to stabilize the banking system has not produced any improvement in market psychology--YET. Mr. Market (see last Weblog) is horribly depressed as he hears the two factions in Washington debating the merits of the process—the un-fairness of it all---and the long term consequences. Many that hoped for a big rally when the stimulus program was passed are now disappointed and disheartened. When will this downward momentum stop? (Remember, Mr. Market does not have any idea of what your investments are really worth!)

You have already experienced the reality that the value of your investments will decline and that you will suffer unrealized losses. A Down-a-lot market surprise has happened. This occurrence is real and recent. There is a danger that you may make the error of Recency Bias, defined as the tendency to be excessively affected by the pattern of recent data. This is the first of what I like to call the “hidden risks of investing”.

The second risk is inflation. It has been a long time since we have experienced double digit inflation, but with huge government deficits and a lot of monetary stimulus, the risk is real. Cash and bonds perform poorly in an inflationary environment.

Another important risk to understand is defined as Benchmark Risk. Of all risks, this is probably the least understood by most investors. There are many fancy technical definitions and measurements used by professional money managers and academics, but the basic principle is reasonably easy to understand. The first step in constructing an investment portfolio is the selection of the correct Asset Allocation and the corresponding Benchmark for you. This can be a complicated process, but for the sake of discussion, let’s assume that one possible Benchmark is the well known general domestic all-equity market index known as the S&P500.

A Benchmark is the standard to which we compare results. Benchmark Risk is created when we deviate from the basic make up and character of that standard. For example, if our Benchmark is the all-equity S&P500 and we decide that our portfolio will move to all bonds and cash. In this case, we have created a risk that the performance of our portfolio may not be comparable to the Benchmark--and that we will not reach the intended long term goal. Here’s a quote from Ken Fisher in his excellent book that I recommend: The Only Three Questions That Count (John Wiley & Sons, Inc.- 2007) “The only time I am ever comfortable beating the benchmark by a lot—taking on massive amounts of benchmark risk---is when I believe down-a-lot is by far the likeliest scenario.”

Nobody can predict market movements with precision. Most people can assign probabilities to four possible outcomes: Up-a-lot, Up-a-little, Down-a-little, or Down-a-lot. The probabilities may not be right, but they are what the investor believes. I agree with Fisher: Jumping out of and into the market and exposing your “investment” portfolio to massive Benchmark Risk by holding large amounts of cash in excess of your known 3-5 year cash needs, is essentially only wise if you are convinced that there is a very high probability of a “Down-a-lot” scenario.

After a real Down-a-lot happening, many choose to believe that “we should have seen it coming”. The word “should” and “could” are much different. Very few, if any professional investment managers would stipulate that anyone could have predicted the last six months of market decline with any degree of confidence. (Some things are un-knowable.) And, taking on big Benchmark Risk can be very costly. In other words, being “safe” in reality may be very risky. Managing risks is what life and successful long term investing is all about. Avoiding risks is a sure path toward lower than average returns.

You should be investing because you need long term returns that appreciably exceed inflation—increasing purchasing power. If you have enough without subjecting yourself to investment risks, then by all means buy more CD’s, short term Treasuries, and hold cash. Then, hope that high rates of inflation are only temporary.

History teaches that a future Down-a-lot scenario is less likely after a 50% market decline. So taking huge Benchmark Risk now is even more risky than usual. The reward is probably not worth the risk. The risk of Recency Bias is very high. What I call “going to cash” at the wrong time can make it difficult or even impossible for you to reach your long term goals or even to recover from the most recent downturn.

While taking on big Benchmark Risk is usually not wise, taking on some smaller risk in the form of tactical increases in sector allocations may be wise. The reward may be worth the risk. (This is part of the value received by active investment management.) Buy, Hold and Hope as an investment strategy may no longer be optimal. We are advising that most portfolios could benefit by overweighting in Energy and Health Care. Some form of hedging against the risk of rising long term interest rates and inflation may also be appropriate. (Call us for more explanation and how these strategies might apply to you.)

In addition, a re-evaluation of the correct Asset Allocation and Benchmark for you is also very appropriate. Circumstances change and your investment portfolio should be set up appropriately for you.

Where is the market going? History teaches us that it is going up. What we don’t know is when. We are telling our clients that there are two scenarios that are highly probable (but not certain). The first is “Investment Purgatory” for a couple years; the second is “Investment Heaven with Inflation” sooner than expected. We advise looking for long term investments that will do better than average in both scenarios. (Call us for more explanation.)

Nobody knows when this market turns. By the time that it looks certain that the market is going up, it will most probably have already risen by a great amount. Missing out will be more permanent than any temporary downturn. This is the real cost of Benchmark Risk.

This commentary and information is provided for the benefit of clients and should not be considered a sales presentation.

See http://www.waynestrout.com/ for more complete info: Investment advisory services are offered by WS Wealth Managers, Inc., an investment adviser registered with the SEC. Wayne Strout is an Investment Adviser Representative with WS Wealth Managers Inc. in addition to serving as President/CEO and Chief Compliance Officer of the firm. Scott Sebring is an Investment Adviser Representative and Vice President. WS Wealth Managers Inc. is not affiliated with Glen Eagle Advisors LLC or Pershing LLC. Wayne Strout and Scott Sebring, dba WS Wealth Managers. Securities offered thru Glen Eagle Advisors LLC, Member of FINRA And SIPC, with clearing thru Pershing LLC, Division of Bank of New York Mellon Corporation, also Member of FINRA and SIPC.

“Early is on time, on time is late, and late is unacceptable”

2009-01-31T13:32:00.000-08:00

January ends with a 8.6% decline in the S&P500. Our new President has been inaugurated and his new executive team is mostly in place. So what happened to the “Hope Rally” that many expected?? Reports about the economy continue to feed fears of a continuing downturn. In order to “sell” a government stimulus plan, along with continued support for financial firms, there is no shortage of politicians warning that “things could get a lot worse!” (Not good rhetoric for markets.)

As mentioned in my previous weblog: “Bear markets do not end until investor psychology changes in regards to the future. They do end when investors believe that all aspects of the economic future are “priced in” and that even though bad economic news may continue—it is expected. And, most importantly, bear markets end when there is HOPE and expectation that the future will be better in the foreseeable future. Always remember that the price of a stock is the market’s guess as to the value of the stock’s FUTURE earnings—not just for the next year or two but many years into the future.”

I think it time for more uncommon wisdom from Warren Buffet:

“Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business.

Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his. Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market's quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.

Mr. Market has another endearing characteristic: He doesn't mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you. But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren't certain that you understand and can value your business far better than Mr. Market, you don't belong in the game.”

At this time of the year, the press will drag out the old “What happens in January determines the stock market for the whole year”. This old saw is reportedly around 80% accurate. But, there is another “indicator” that is almost accurate 80% of the time: If the Super Bowl winner is a team that can be traced back to the original NFL, the market goes up that year! (Since both teams in the 2009 Superbowl can be traced to the old NFL, the market is predicted to rise!) The market has “tested” the November 20th bottom of 752 for the S&P500 more than once. There are those that will claim that this has “confirmed” the bottom and the market is likely to rise.

These forms of what I like to call “pattern searching” can lead to very poor judgments about investing. While we can learn from history, trying to predict the future by using over-simplifications of the past is unwise.

Remember several important points:

Markets often rise, even when the present economic news is not very positive. Markets tend to ANTICIPATE the future. Markets are moved by surprises—not what is expected. Prices of stocks are the market’s guess as to the value of the stock’s FUTURE earnings—not just for the next year or two but many years into the future. And, as Warren Buffet reminds us: “Mr. Market is there to serve you, not to guide you.”

Mr. Market is now so depressed, he has cut the price of equities nearly in half. In fact, he has set prices so low, that the annualized ten year return for large cap stocks from 1998 thru 2008 (-1.5%) is worse than anytime in history since 1810. The previous record was during the Great Depression 1928 thru 1938 with -1.3%. We have just experienced the worst 10 year “bear market” in history.

In order to be a successful investor, you must stay in the game. Yes, you will experience downs (known as unrealized losses) but in order to get the average return, you must be invested so that you get the full benefit of the upside. And, if you are fortunate to hold cash when the market is down, you can exceed the average by buying low.

It has been said that “the early bird gets the worm”. On the other hand, it has been said, “the second mouse gets the cheese”. (I’d rather be an eagle than a mouse---and smart investors are supposed to be more careful than your average mouse.)

Where is the market going? History teaches us that it is going up. What we don’t know is when. We are telling our clients that there are two scenarios that are highly probable (but not certain). The first is “Investment Purgatory” for a couple years; the second is “Investment Heaven with Inflation” sooner than expected. (Call us for more explanation.) We advise looking for long term investments that will do better than average in both scenarios.

Nobody knows when this market turns. By the time that it looks certain that the market is going up, it will most probably have already risen by a great amount. Missing out will be more permanent than any temporary downturn…so:

“Early is on time, on time is late, and late is unacceptable”

This commentary and information is provided for the benefit of clients and should not be considered a sales presentation.

See http://www.waynestrout.com/ for more complete info: Investment advisory services are offered by WS Wealth Managers, Inc., an investment adviser registered with the SEC. Wayne Strout is an Investment Adviser Representative with WS Wealth Managers Inc. in addition to serving as President/CEO and Chief Compliance Officer of the firm. Scott Sebring is an Investment Adviser Representative and Vice President. WS Wealth Managers Inc. is not affiliated with Glen Eagle Advisors LLC or Pershing LLC. Wayne Strout and Scott Sebring, dba WS Wealth Managers. Securities offered thru Glen Eagle Advisors LLC, Member of FINRA And SIPC, with clearing thru Pershing LLC, Division of Bank of New York Mellon Corporation, also Member of FINRA and SIPC.

Is it over yet?

2008-11-15T09:54:00.000-08:00

In last month’s commentary I wrote: “Nobody knows where the bottom is exactly, but this decline (in early to mid October) is now exhibiting the normal historical pattern of maximum fear. It is probably near the ultimate CAPITULATION point.” I warned however that the amount and duration of large hedge fund liquidations could change the normal pattern.

History teaches us that bear market bottoms are typically “retested” at some point. Usually this is 30-40 trading days after the first potential bottom. This 30-40 trading day period is not yet complete, but will be soon. I believe there are two major factors that may also affect the “normal” bear market behavior. The first is the change of government administration. The second is the almost unprecedented bad economic news coupled with unprecedented pessimism in near term future economic outlooks.

Bear markets do not end until investor psychology changes in regards to the future. They do end when investors believe that all aspects of the economic future are “priced in” and that even though bad economic news may continue—it is expected. And, most importantly, bear markets end when there is HOPE and expectation that the future will be better in the foreseeable future. Always remember that the price of a stock is the market’s guess as to the value of the stock’s FUTURE earnings—not just for the next year or two but many years into the future.

A study of historical stock market (S&P500) returns in the 1930’s disclose some very interesting facts. After a terrible three year decline from October, 1929 to the 1932 election, with a “transformational” Democrat replacing an unpopular Republican, the market declined 5% in November immediately after the election. But, from October 1932 through October 1933 it rose almost 34%. In the four years from October 1932 to October 1936, the market rose nearly 270%. Yes, it went UP 2.7 times over four years! This was in the midst of the Great Depression! (In that 1933 period when the market rose 34%, unemployment reached 25%. Although the U.S. economy began to recover in the second quarter of 1933, the recovery largely stalled for most of 1934 and 1935.) The point is that markets often rise, even when the present economic news is not very positive. Markets tend to ANTICIPATE the future.

In the short run markets are mostly affected by psychology. Maximum fear is almost always the bottom. Can fear get worse? It depends on whether economic news is worse or better than previously feared. (We have probably already seen the market's reaction to fears regarding possible tax policy changes by the new administration.) When fear is replaced with hope, markets change direction. Sooner than later investors determine that no matter how bad things may become in the near future—things will get better and good times will return!

No, it is not yet over. We will most likely see continued volatility. But, for your long term investments, it is probably not a good time to exit. And it may be an excellent time to add to positions in high quality equities and mutual funds.

This commentary and information is provided for the benefit of clients and should not be considered a sales presentation.

See http://www.waynestrout.com/ for more complete info: Investment advisory services are offered by WS Wealth Managers, Inc., an investment adviser registered with the SEC. Wayne Strout is an Investment Adviser Representative with WS Wealth Managers Inc. in addition to serving as President/CEO and Chief Compliance Officer of the firm. Scott Sebring is an Investment Adviser Representative and Vice President. WS Wealth Managers Inc. is not affiliated with Glen Eagle Advisors LLC or Pershing LLC. Wayne Strout and Scott Sebring, dba WS Wealth Managers. Securities offered thru Glen Eagle Advisors LLC, Member of FINRA And SIPC, with clearing thru Pershing LLC, Division of Bank of New York Mellon Corporation, also Member of FINRA and SIPC.

Shouldn’t we be doing something?

2008-10-08T12:08:00.000-07:00

Human nature is almost always wrong when it comes to investing. Many times, the most value a Financial Advisor can provide to a client is to help them GO AGAINST their human nature.

Our nature tells us to avoid injury by taking action in response to pain. In investing that means we want to sell that investment that has caused us pain and worry by going down in value. Investing is all about selling after prices go up and buying after prices go down.

The S&P just closed at 996. That is down nearly 22% in the last thirty days. It is down 36% from 1565 since one year ago. It is usually unwise to sell after a 36% decline!

“But I just don’t want to lose ALL my money”. A well diversified portfolio of quality investments usually does better than the market. So let’s look at some really bad markets: 2000-2002= 40% down to 833; 1972-1974=43% down to 65.

The worst market in my lifetime was 1972-74 and we are now UP 15 times from that point! ($100,000 in 1974 invested in the S&P500 might have grown to $1,500,000!!) The "price paid" to earn $1,400,000 in 30 years was to "suffer" two storms with declines of more than 30%. (This ignores dividends. With dividends reinvested, some mutual funds like American Funds Income Fund of America grew much more over the 30 year period: $100,000 growing to over $4 million-see July Blog)

Nobody knows where the bottom is exactly, however, this decline is now exhibiting most of the signals consistent with the normal historical pattern of maximum fear. It is probably near the ultimate CAPITULATION point. After capitulation comes APATHY for awhile, until some event causes a change in sentiment and GREED starts replacing FEAR.

If there were no hedge funds, it is possible that CAPITULATION occurred on October 7, but hedge funds cause irregular and unpredictable behavior. The rich and foolish folks in hedge funds have suffered huge declines from GAMBLING and want out… and the volume is big—it may take awhile for the market to accommodate their exit. Market action on October 8 seems to confirm this.

My best advice is to think of what you are experiencing as a sea voyage. We are in the middle of the ocean and a big storm has come up-with big waves. We are not going to turn the ship around nor are we going to abandon ship in the middle of the storm—we wait till the storm is over, make the necessary course corrections and continue toward our destination of financial freedom.

If you are a client of this firm, your investments were designed to survive storms like this. Your captain and crew have “many years at sea” and unlike the Titanic, you have not been sailing at maximum speed at night. The storm will end and the sun will shine again—be patient, stay the course and look for opportunities.

Please review the August Blog that discusses the Panic of 1907:

Mutual Funds-Corporate Farming

2008-08-23T11:21:00.000-07:00

If investing should be like farming, what if we really don’t want to be farmers? What if we want to own the land but let somebody else do the farming and produce rising income for us?

Delegation to professionals with more experience, judgment and tools of the trade is almost always a wise decision. This of course assumes that the professionals charge a fair price, where the value they provide exceeds the cost of their services—and they are competent.

Owning and working a 1000 acre farm can be a good source of income. Owning and renting out a 1000 acre farm can provide a modest income. What if we want more income than we can get from renting, but we don’t want to work the farm ourselves? And, what if we want to diversify our holdings so all of our “land” is not in one place and so we can grow many more different types of crops?

When we buy shares in a mutual fund, we are buying an ownership interest in an investment company. We share in the income generated by that company. Using the farming analogy, we can buy shares in a “corporate farm” with vast “land” holdings in many geographical areas, with a diverse group of crops, providing the benefits of diversification. The benefits of a mutual fund are primarily: Professional Management; and Diversification.

The goals and general activities of the mutual fund are outlined in a prospectus. Never invest in a mutual fund without reading the prospectus and gaining a complete understanding of the fund’s goals, activities, management, costs, financials and track record. (Have a professional assist you.)

Because the mutual fund has professional management and more resources, it can often add another dimension to your investment activities. Here, ongoing income from Capital Appreciation is perhaps possible by buying “land” when it is cheap, and selling it later when prices for it have risen. In other words, the management is not only engaged in the business of farming and producing income; they are engaged in a professionally managed form of “land speculation”. Unfortunately, many of these professional managers have no better idea of how to make money buying and selling land than the average Joe or their fees are so high that any value they add is more than offset by the costs.

So, how do you choose?

Our firm believes the right choices are finding mutual funds with competent management, with the right philosophy, that spend their time on truly value adding activities, and that keep their costs low. We define competent management as having sufficient experience to have learned the lessons of the past; that understand following the crowd is usually unwise. We define the right philosophy as a focus on managing risk: capturing “less of the downside” and “more of the upside” but not necessarily all of the upside in fluctuating markets. (You would be surprised how many mutual fund managers think doing a good job is simply following the market-up AND down!) The right philosophy also includes an understanding that it may take years for the wisdom of their decisions to show. Finally, there is only one way to gain an advantage in buying and selling property—real “in person” inspections of the property. The same type of in person inspections you would undertake yourself. There are remarkably few mutual funds that meet our firm’s criteria for being the “right choice”.

With professional management and the potential for the added dimension of “harvesting” long term gains from Capital Appreciation, a professionally managed, highly diversified portfolio can produce a relatively stable long term source of rising income. In many cases this rising income can be more predictable.

This commentary and information is provided for the benefit of clients and should not be considered a sales presentation.

The Goal-Think Like a Farmer

2008-08-23T10:03:00.000-07:00

“Everything should be made as simple as possible, but not simpler.”- Albert Einstein

Whether the client intends to take income (now or later) or to build a legacy to be gifted to others, we assert that the universal goal of investing is to create a present or future source of rising income. Rising income is defined as income that grows at a rate that exceeds inflation. Sometimes that income is spent, sometimes it is reinvested. When past or present income is spent, the investment portfolio is deemed to be in the “Distribution” phase. When new funds are being added or income is reinvested, the investment portfolio is deemed to be in the “Accumulation” phase. There are only three sources of income from investments: A) Interest; B) Dividends; and/or C) Capital Appreciation.

We believe that a simple way to illustrate this concept is to use the analogy of investing compared to farming. A farmer can take income in three ways: A) Renting the land; B) Growing and selling harvested crops or mature livestock; and/or C) Selling off parts of the land. Rent is like interest. Dividends are like the income from growing and selling harvested crops or mature livestock. Capital Appreciation is like income from selling off parts of the land that have become more valuable.

Unfortunately, too many so called “investors” believe that investing is all about Capital Appreciation. Coming from a family with a long farming tradition, we can say that most farmers and growers do not calculate the value of their farmland on a daily or monthly basis. And, few even think about selling it off. Farmers understand that the source of their wealth is the land, but that the value of the land is determined primarily by the income derived by growing and selling harvested crops. We like to think of the client’s investment portfolio as the “land” and dividends and interest as the “harvest”. If we don’t need the income from the “harvest”, we buy more “land” by “reinvesting” the dividends and interest (Accumulation). If we need the income, we take money from the “harvest” and spend it on ourselves (Distribution).

We tell our clients that the value of their investments is determined primarily by the income generated now or likely to be generated in the future, from dividends and interest. We worry little about the daily market value of the “land” except when we are adding new money and “buying” more. If we learn that the value of “land” has increased, we have mixed feelings..we feel wealthier, but..if we are buying land, we will be able to buy less with our money.

We submit that the only time that Capital Appreciation is important is if we intend to sell, and the only time we would sell our “land” is if our income was insufficient for our needs. (Or maybe if we want to buy more “fertile” land that will produce more income.) The goal of investing, particularly for retirement is for our portfolio to produce income sufficient for our needs. This is investing as opposed to speculation.

While earning interest (renting the land to another farmer) is an important and relatively stable way to create income, unless the portfolio is very large and our income requirements are very small, dividends are generally the most important source of income. Owning stocks, in the farming analogy, is like the growing and selling harvested crops. Some stocks are like growing corn or milking dairy cattle, where the income comes right away, some stocks are more like planting orchards or trees, where income comes after a period of time.

Spend less energy worrying about the daily value of your investment portfolio and more about how much income it is producing or will be producing in the future.

This commentary and information is provided for the benefit of clients and should not be considered a sales presentation.

Speculation vs. Investment

2008-08-16T10:37:00.000-07:00

“Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works.”- John Mills (1868)

A simple definition of speculation is that it is a process, a form of gambling driven by greed, where something is purchased primarily because that something’s price is expected to rise over time. Speculation is a process that feeds on itself, for a period of time, where buying something in limited supply, drives the price up for a period of time, creating demand for more buying, simply on the premise that the price will continue to rise. The most dangerous forms of speculation is where borrowed money is used in the process. Widespread and increasing use of borrowed money allows prices to rise in the short term at unsustainable rates.

Continued increases in prices require rising demand without a corresponding increase in supply. The greatest misperception is that demand and prices will rise indefinitely because supply is somehow permanently limited.

Some would argue that for “scarce” goods like real estate or oil with finite quantities available for supply, prices can rise at faster rates. This argument fails to consider the creative ability of humankind to create “competitive substitutes” and to become more “efficient”. When the price of something is perceived as “too high” then buyers begin to consider alternatives or become more efficient, and demand for the “scarce” good falls---and the rate of price increase slows. When the price of something becomes sufficiently high, new sources of supply of the “something or it’s substitute” are found and even with rising demand, prices fall.

Hence, successful speculation requires an ability to determine when to sell, before prices fall. Here is where fear enters into the process, because greed tells buyers to “stay in the game” while fear tells them to “get out while the getting is good”.

There are only two long term causes of sustainable increases in demand and aggregate wealth: increased population, and increased productivity of humankind allowing each person to consume more. Increased productivity requires capital, tools and free trade. Increased productivity requires investment, not speculation. In fact, speculation and investment are really in competition with one another.

Speculation does not increase wealth—it only transfers it. Speculation is seldom a productive use of time or any other resource and repeated speculation usually results in losses that offset the gains. Our firm believes the process of investing is the intelligent application of capital for the purpose of increasing humankind’s productivity over time. This increased productivity is in our opinion the most reliable way to increase wealth over time.

There will always be speculation—it is a part of human nature. But during periods when speculation has proven to be unprofitable for the majority of participants, it becomes relatively less popular. Our firm advises clients to seek out well managed companies that use capital wisely for the purpose of increasing the productivity of humankind. These are the investments that more reliably create wealth and value. During periods with “corrections” of past speculation, the price to buy these companies is particularly attractive. When speculation becomes less popular, true investing for long term results becomes even more rewarding.

This commentary and information is provided for the benefit of clients and should not be considered a sales presentation.

See http://www.waynestrout.com/ for more complete info
Investment advisory services by WS Wealth Managers Inc., a registered investment adviser.
Securities thru Glen Eagle Advisors, LLC, Member of FINRA and SIPC

Clearing thru Pershing LLC, Div of Bank of New York Mellon Corp.
WS Wealth Managers Inc., Glen Eagle Advisors LLC, and Pershing LLC are not affiliated.

Uncertain Times Require Courage Wisdom and Patience

2008-08-02T09:57:00.000-07:00

Unemployment rates go up. Dollar rises.
Oil prices down. Gold prices up.
Money supply and credit contracts. Inflation up.
2nd Quarter 2008 GDP up. 4th Quarter 2007 GDP revised down into negative territory.

The stark truth is that nobody knows for sure what the near term future holds. This is why there is so much volatility in the markets. We are in a period where “frightened money” jumps in and out of markets and anxiety rules.

Uncertain times bring to mind a quote from John F Kennedy: “The Chinese use two brush strokes to write the word CRISIS. One brush stroke stands for danger; the other for opportunity. In a crisis, be aware of the danger – but recognize the opportunity.”

From my experience, the biggest error that can be made is trying to predict the future by looking backwards. It is sort of like driving by looking out the rear view mirror instead of the windshield. Always remember, there is a BIG DIFFERENCE between predicting the short term future from recent past events and preparing for the future by studying history and what it teaches us. Being prepared is how money is made, not by making predictions. Markets move because of what is NOT KNOWN.

J. P. Morgan, the famous financier, and one of the richest men in the US, was once asked what he thought the markets were going to do. His answer was “The markets will fluctuate!” We can learn from history by looking back on periods when necessary corrections always follow the inevitable periods of human excess. Go back to the Panic of 1907…Speculation in the 1900’s was rampant. Trusts Companies then, like the Investment Banks and Hedge Funds now had fueled this speculation. There was a run on a major financial institution, followed by a bailout. The markets slid downward as anxiety continued. The Dow Jones Average fell from 86 to 53 over 8 months (March thru November). The total return for US Equities in 1907 is estimated to have been a negative 30%. The total return for US Equities the following year was UP 44% with another UP 18% in 1909.

(Keep in mind that 1907 was the year before the 1908 election. During the election year of 1908, the market was up considerably—more than 40%. Markets are usually up during election years. There is still another 5 months to go in 2008!)

Why study a period more than 100 years ago? Things are different—right? Our firm believes that markets in the short term are driven more by human nature than by facts. Markets always overreact. Greed and Fear—the two Enemies of investing (or Allies if you use them to your advantage) have not changed much and there is much to learn from history.

A “buy and hold” investor owning the “index” would have achieved a theoretical average return of 6.5% over the three year period 1907-1909. An investor with courage and patience, buying in August of 1907 would have achieved an average annualized return of over 10% owning the “index” thru the end of 1909. (The ride would have required a great deal of courage indeed. The DOW fell more than 30% from August thru November of 1907!) It would take another 18 years before the market index doubled, providing an average annualized return of only 4% during that period. Above average returns from investing required careful stock picking, a preference for stock where dividends added to the total return, and careful selection of interest paying bonds.

The point here is that buying the “index” and “passive investing” may not be the most prudent investment strategy going forward. Periods of speculation are generally times when it is easy to make money—follow the crowd and put it on auto-pilot. Perhaps a strategy with more focus on value and income will be the best strategy going forward. Corrections and the years following periods of speculation are times when it is harder to make money and it is usually wise to go the exact opposite direction of the crowd. Using a trained professional is also advisable.

Focusing on value and rising income is a good strategy ALL OF THE TIME. It takes work, and it is usually easier if you rely on the assistance of professionals. Being a growth oriented value investor takes courage, wisdom, and patience.

Nobody knows whether the market is going to go up or down in the near term. What is more important is: Overcoming fear, buying good quality investments at favorable prices and holding them, having patience, until they substantially increase in value has proven to be a winning strategy. (Be sure to keep some cash on hand and/or income producing investments as needed to hold you over during the rough times.)

Making Money Even if the Market does not Go Up.

2008-07-09T10:12:00.000-07:00

Nobody knows for sure which way this market is headed in the short run. My firm’s motto is “Being prepared is more important than making predictions”. We cannot predict market movements with certainty, but we can assess or estimate probabilities-that is part of being prepared. But it must be remembered that an 80% probability of something happening is still 20% from being certain.

In my previous blog, I mentioned that it looks like we might already be in a period that is similar to the 1970’s. Casual conversations with friends or family and business conversations with clients invariably displays a level of pessimism and fear not seen since Jimmy Carter was President. Fear of inflation, fear of losing a job or business losses, fear of general economic decline.

Inflation is obviously present in the price of petroleum, commodities, and food. So, what’s the cause? Extraordinary global economic growth is the reason. Developing economies are experiencing “demand pull” inflation with rising wages. Developed economies are experiencing “cost push” inflation which is restraining wages. Demand pull inflation tends to feed on itself, generating more inflation and a boom/bust cycle. (The recent home price bubble in the US is an example.) Cost push inflation tends to result in an economic correction and a general pessimistic feeling--that of "being out of control". (Having to pay more for our corn flakes because the farmer is now getting $7 a bushel for his corn instead of $3.)

Oil and commodities are priced high because of strong demand. According to Fed President. Janet Yellen, since 2000, world demand for oil has increased by 11 million barrels a day (14%) without a corresponding increase in supply. And commodities that are not traded by speculators are up as much or more than oil that is traded by speculators. We have a classic demand pull inflation going on. Probability is high that such booms are followed by busts. I personally think that commodities and oil can continue rising, but the probability is better than 50% that we are very near the top. Be careful not to jump on the bandwagon just before it falls of a cliff.

Although we like to think of real estate as an investment, for the vast majority of people, real estate is a cost. As the price of real estate declines, it creates deflationary effects. Housing is in the process of becoming more affordable. While the price of gasoline and food rises, the demand for most everything else declines. This also can cause deflation. While the price of fuel may cause producers to want to raise prices, there has to be demand or nothing gets sold. Money supply growth drives inflation and a decline in the money supply creates deflation. The credit correction we are experiencing is causing huge pressures toward a reduction in the money supply--offset (maybe only in part) by aggressive moves by the Fed. The probability is high that risks of deflation are almost the same as inflation.

Inflation produces winners and losers. You may not like paying higher prices for food, but even though few admit it, farmers are experiencing better results than they have seen in decades. While this is a difficult market for home-builders, there is still demand for housing and apartment owners are doing pretty well. This is the point of the mantra—“You must own a diversified investment portfolio”.

So as Franklin Roosevelt said, “We have nothing to fear but fear itself”. And, my view is that markets are more affected by fear of the unknown than fear of any known event or trend. Although we never really know the future with certainty, we feel better when we think we do! In periods of fear, be "courageously cautious" and seek out bargains that will be the source of out-sized future returns.

It is highly probable that markets are closely correlated with corporate profits. And corporate profits have been declining since the 2nd qtr of 2007. It is highly probable that corporate profits may continue to decline or remain flat for quite some time. So, our investment portfolios should be adjusted to focus on diversified sources of rising income. These sources are companies that have corporate profits that are predictable and relatively stable.

There are three sources of investment income: interest, dividends, and capital appreciation. Most likely interest and dividend income will be relatively more important in the near term than they were in the boom periods of the 1980’s and 1990’s. Choosing companies that generate real income and reinvesting that income will produce rising income over time. Choosing the correct mix of dividend and interest income will depend on each individual’s circumstances. More “certain” income from fixed income investments is generally recommended if you are taking income from your portfolio. This has become relatively more important. And, given the deflationary pressures discussed above, a laddered portfolio of fixed income investments will probably approach historical norms for total returns.

So, is the market going up or down? History teaches that it is probably going up in the long run. And we believe that the current market is likely to move up as we approach the end of summer. (60-80% probable) However, given political risks associated with the elections (because of changes in tax policy) and the chance that we are near the end of a boom period in developing countries, we are advising a slight reduction in international exposure and more emphasis on stocks that pay attractive dividends. Look for opportunity where prices have fallen and dividends are higher yields than historical averages-and where the dividend would still be attractive even if cut by 30-40% in the short run.

Take a look at companies like FR, DRE, FPL, IBDRY and BMY. (Not a recommendation—suitability is determined by many factors and a decision to buy or sell should not be made until having first consulted with a qualified financial advisor who will help assess your current situation and risk tolerance.) Companies that provide necessities and where the “trend is your friend” are the stocks you want to own going into the near future. BMY is in health care and will benefit from the aging population—even with more government controls on costs. FR and DRE are REIT’s that benefit from the trend of growing world trade. FPL and IBDRY are electric utilities that are leaders in alternative energy from wind. Avoid speculative positions and holdings--the chance of being disappointed is very high.

By carefully selecting the correct assets and allocation, you can make money, even if the markets do not go up.

Note: Strout and/or Strout's family have positions in FR, DRE, IBDRY and BMY.

See http://www.waynestrout.com/ for more complete info: Investment advisory services are offered by WS Wealth Managers, Inc., an investment adviser registered with the SEC. Wayne Strout is an Investment Adviser Representative with WS Wealth Managers Inc. in addition to serving as President/CEO and Chief Compliance Officer of the firm. Scott Sebring is an Investment Adviser Representative and Vice President. WS Wealth Managers Inc. is not affiliated with Glen Eagle Advisors LLC or Pershing LLC. Wayne Strout and Scott Sebring, dba WS Wealth Managers. Securities offered thru Glen Eagle Advisors LLC, Member of FINRA And SIPC, with clearing thru Pershing LLC, Division of Bank of New York Mellon Corporation, also Member of FINRA and SIPC.

Stay the Course and Look for Opportunity

2008-07-01T12:31:00.000-07:00

It is easy to be an "investor" when your account continuously increases on a regular monthly and quarterly basis. Obviously, being an "investor" from October 2007 to now is not quite so pleasant. June was "scary" for almost everybody.
I like to say that the price you pay for long term growth in your portfolio is having to experience these downturns. Sometimes they last for months...sometimes for years.
Warren Buffet has supposedly stated "Occasional outbreaks of ...fear and greed, will forever occur in the investment community. The timing of these epidemics is equally unpredictable, both in duration and degree. Therefore we never try to anticipate the arrival or departure of either. We simply attempt to be fearful when others are greedy and greedy when others are fearful." The VIX still below its highs notwithstanding, there is a lot of fear out there. For those that have cash on the sidelines, clearly it is near the time to become greedy! (Keep in mind that every day we have the chance to buy, sell or hold. Staying the course is essentially the same as buying your existing portfolio.)
In any case, this is not the time to be liquidating and probably not even the time to be sitting on the sidelines except...Be sure you have enough cash and income to "ride out the storm" without selling good investments at the wrong time. Enough in today's environment is enough for the next 3-5 years.
If we are to learn from history, it is probably useful to revisit the early 1970's. (A serious oil "price shock" occured then, like we are now having. Except then, we had to wait in lines to get gasoline. This was when the 55 mph speed limit was imposed.) Serious long term investors, even buying at the peak before the downturn were rewarded for staying the course and owning good quality investments. But, the duration of the "storm" starting in January 1973 was three years. The S&P500 fell from 119 in January to 97 in November 1973 and then to 64 in September 1974, rising back to around 100 in January 1976. By January 1983, ten years from the previous peak, the S&P500 had risen to 145.
A good quality investment, here defined for discussion purposes as American Funds Income Fund of America, a mix of dividend paying stocks and good quality bonds (AMECX) turned in a better performance: $100,000 (Net Asset Value) on November 30, 1973 weathered the two to three year storm, falling to $94,000 at the end of 1974 and rising above $100,000 in 1975. By January 1983, after all dividends were reinvested for the ten year period, the $100,000 had grown to around $322,000. (According to American Funds Hypothetical-do not invest before reading the prospectus, reviewing all required disclosures, and meeting with a qualifed Financial Advisor. Be sure that your risk tolerance and complete financial situation is reviewed to determine that any investment is suitable for you.)
Another possible good quality investment (here again defined for discussion purposes) would be American Funds American Mutual Fund, a diversified stock mutual fund. (AMRMX) A purchase of $100,000 at near the peak of the market around the begining of January 1973, after the 3.5% sales charge leaving $96,500, fell to $72,000 by the end of 1974. The investment, with dividends reinvested rose to $322,000 by January 1983. (Again according to American Funds Hypothetical-do not invest before reading the prospectus, reviewing all required disclosures, and meeting with a qualified Financial Advisor. Be sure your risk tolerance and complete financial situation is reviewed to determine that any investment is suitable for you.)
The index fell 34%, and gained a total of 49% in ten years. (97 to 64 to 145) AMRMX and AMECX fell less, and gained 322% in 10 years. (AMRMX: 100 to 72 to 322- Jan '73 to Jan '83 and AMECX: 100 to 94 to 322- Nov '73 to Jan '83). Keep in mind, history and past performance do not predict the future. This is not a recommendation of AMRMX or AMECX. It is an illustration (for discussion purposes) of how money can be made, even if the stock market does not go up very much by investing in good quality investments with the help of professional management.
Experienced investors are only fearful when markets are too high and when everybody seems greedy. Experienced investors see market drops, dips, corrections and bear markets as opportunities.
When you are in the middle of a downdraft, like now, there will be no shortage of "Doom and Gloom" and claims or fears that "This time it's different". The 1970's were scary. 1987 was scary. 2002 was scary. Yet, the markets recovered in each case.
In closing, investing is not about what happens in 1 year or 3 years. Investing is more about what happens over 10 years. Be sure you have cash and/or income so that you can Stay the Course and Look for Opportunity.