Today there was a lot of bearish news. After the stock market had been going up with minimal dips for six month it finalled dipped with the SP decling 2%, Nkkei down 1.8%, Shanghai down 2.6%.
Robert Shiller forecasted continued price declines in housing of up to 25% in some cases. CoreLogic said NAR had overestimated the number of home sold since 2007 by 20%. Oil exploded upwards with some gas stations charging $4 a gallon for Regular gas in California.
Last week week Bloomerg article comemnted that is is unusuall to have a rally for so long with no dips-well now we have a dip! Does that mean it is time to buy on a dip? No. When the PE ratio goes to 8, or 9, or 10 then it is time to buy. This would be about 600 or less for the SP.
Independent investment advice is needed now to protect for being mislead by sell-side brokers.
The 4 Percent Rule -- What is the Right Amount to Withdraw from Your Retirement fund each year?
With stagnant incomes and roller-coaster investment returns over the past decade, individuals
on the brink of retirement might wonder what became of all those “rules of thumb” affecting how
they handle their nest egg once they walk away from their jobs.
They’re still there. But the question of how well they work comes down to the individual.
Chief among them is the “Four Percent Drawdown Rule” first revealed by CERTIFIED
FINANCIAL PLANNER™ professional William Bengen in the October 1994 issue of the
Financial Planning Association’s Journal of Financial Planning. Bengen wrote that retirees who
took out no more than 4.2 percent of their mostly stock-based portfolio in the initial year and
adjusted their remaining portfolio toward a 60/40 split in stocks and bonds each year, that
money could last an average of 30 years. That approach made Bengen’s work a gospel in the
financial planning industry.
But after this decade, which ended with the worst recession in 70 years, some experts are
taking a new look at the 4 percent rule.
1990 Nobel Laureate William Sharpe of the Stanford Graduate School of Business reported last
month that this particular rule can be harmful to many simply because of its level of risk tied to
stocks and other assumptions including lifespan. He suggests that planners and investors need
to do a better job of assessing client risk tolerance and consider more stable investment choices
like TIPS (treasury inflation protected securities) among other low-risk options as a foundation
for post-retirement drawdowns.
In other words, consider client risk tolerance and the content of the portfolio more, a standard
percentage of drawdown less. In fact, Sharpe points out that investors actually risk wasting
money by adhering to a percentage drawdown that actually could leave more money behind
after a few good investment years – in essence, the annual strict drawdown concept could lower
a retiree’s standard of life unnecessarily.
So what do you do? You work on the big questions first, not the numbers, and the best time to
do this is as far in advance of your retirement date as possible. Here are some conversation
starters for key discussions you should have with your financial planner as well as your tax and
Set a vision of retirement and revisit it every year before and after you’re retired: If you’ve
already been working with a good investment manager or financial planner, you might have
already done this. But retirement goals change as most life goals do, so treat the subject
organically. Talk about the fun stuff, but state your objectives for a post-retirement work picture
if you want to create a new career or simply want healthier finances. Set your lifestyle
expectations now and revisit them as necessary.
Track your working-life expenses for 3-6 months and examine how well your current
retirement nest egg and other resources could support that spending: This is where your
imagined vision of retirement becomes real -- or falls apart. A thorough examination of your
current spending habits is a great first step in determining how realistic your preparation for
retirement has actually been. It will also provide a picture of what else has to be done.
Consider worst-case scenarios: For many retirees, increasing healthcare expenses and the
cost of end-of-life-care account for significant spending. As a result, many retirees may pay for
expensive experimental treatments to fight disease or long-term home or nursing home care.
Current statistics from AARP show that the average home health care aide makes $18 an hour
and a private nursing home room costs $78,000 a year. While public aid picks up medical
expenses for those who exhaust their assets in most states, most of us desire more than
minimal standards of care. Health care reform is not even close to solving this problem, so it’s
time to plan.
Build a phased-in retirement: Many companies are becoming more open-minded about
keeping older workers on the payroll or actually hiring more workers over age 60. Keep
apprised of such opportunities and the skills it will take to take advantage of them – a successful
phased-in or post-retirement work plan will require more than sensible financial planning. It may
also require training and other personal investments, so keep your ear to the ground and always
be ready to consider a fresh perspective on your value in the workplace.
Originally written July 2010 — This column is produced by the Financial Planning Association, the membership organization for the financial planningcommunity, and is provided by Don Martin, CFP, a local member of FPA.
Risk-aware investing means to judge an investment by its risk adjusted rate of return. This means using Sharpe ratio or Information ratio to see how much reward did you obtain in return for the risk you took. The goal is to spot investments that had a high performance but were so risky that they really did not make enough profit to offset or to justify taking the risk. Using this technique means an investor may make less than another investor who takes on excessive risk however an investor who uses risk-aware techniques may be able to reduce the probability of serious losses. However, nothing about investments is guaranteed and past performance is not indicative of the future.
The theory behind risk aware investing is to take reasonable risks and to avoid unreasonable risks. A simple technique would be to sort investments by Standard Deviation and reject those in the highest quartile, or possibly reject those in the highest half. This would result in a lower rate of return but would increase the probability of avoiding catastrophic risks. Some experts believe that the most important goal in investing is to avoid losing money. For example, if you have $100 invested and lose 50% then when the investment that is now worth $50 later goes up by 50% you now have only $75.
How does the Sharpe ratio work? It subtracts the T-Bill rate of return from the investment’s return and divided by Standard Deviation of the investment. This shows how much alpha (excess return) you got divided by the amount of risk. This allows you compare reward in proportion to risk. The problem is that today T-Bills are close to zero yield. Further, the excess or alpha return that you got from the investment should be compared to the same asset class. For example, if you invest in large cap domestic stock then instead of using T-Bill rate to determine alpha, use the large cap average rate of return to determine what your investments alpha was. This is done using the “Information ratio”, which uses a benchmark that is similar to the asset class you are examining to determine alpha. This is a crucial difference between the Sharpe ratio versus Information ratio during eras when the Fed is making interest rates artificially low.
The challenge is that past booms can lead to bubbles so that the investment with the best Sharpe or Information ratio in the past may have reached its peak and will be ready for a crash if it is overpriced. So you can’t simply look at what stock had the best Sharpe or Information ratio, you also have to examine the intrinsic value by looking at the 10 year P.E. ratio to see if it is reasonably priced and you need to look at the possibility of the “value trap” phenomenon which occurs when a stock is declining the p.e. ratio looks better but the stock is in danger of collapsing. In addition it is important to look at corporate financial health, corporate moat, return on equity, growth rate of sales and earnings. Also, if interest rates are set by the Fed at historic lows then they may have temporarily and artificially increased the value of the stock market, which will put downward pressure on stocks, once the Fed raises rates to normal levels.
This is an example of independent investment advice.
According to an article in MSN.com January 3, 2011 the average stock ownership lasts 22 seconds due to computerized trading. That’s right: 22 seconds, not 22 days or 22 weeks!
My opinion is that this supports my theory that a huge amount of stock investing is done by hedge funds that have access to margin loans with a nearly zero percent cost of capital so they can afford to buy with enormous leverage, thus pushing up or supporting stock prices that are too high. Hedge funds leverage is between 4 to 10 times their net worth. If this support from hedge funds were to be withdrawn due to their inability to get financing, or to buy Put options, etc. then they would need to sell their stocks. And that would create a massive wave of selling where they would face margin calls and then they would be able to sell poor quality stocks and would be forced to sell good quality stocks at fire sale prices. If margin requirements or the price of Put options or interest rates were to increase then this house of cards would tumble down very fast and stay down.
I have wondered for years why the stock market has been so high compared to 100 year trend lines for things like P.E. ratios, etc. I think the answer is that in the last 20 years there has been an enormous amount of hedge fund investing using a very cheap cost of borrowed money and it has gotten progressively cheaper to borrow over the past 20 years, also Put option costs have gone down recently, with the VIX at record lows. Further the bailout of Long Term Capital management in 1998 and Bear Stearns has encouraged hedge funds to take on excessive risk.
One way to protect oneself from this is to use independent investment advice, instead of getting advice from giant Wall Street oligopolies.
Should investors seek professional independent investment advice for a fee during a bear market or should they try to “save” money by not using an advisor and simply putting all their funds into an insured CD?
When an investor hears that an advisor is bearish the investor maybe tempted to think he can save money by simply parking his assets in an insured CD and thus avoid paying for investment advice. However, the investor risks missing advice about when is the right time to get back into the market. The investor may miss advice on contrarian strategies that may be feasible during a range bound bear market. An investor who shuns the advice of a bear market advisor may end up being fooled by a bubbly bullish demagogue who encourages buying stocks at the top of the market, which would result in losses.
Perhaps the most important rule in investing is to avoid losing money. This is because for example, if you lose 50% then you need to make 100% to get back to even. Also if you suffer big losses you may feel too frustrated to invest and then miss the rally that occurs after a crash. So for this reason it is more important to get professional advice from a bear market advisor than it is to get bullish advice during a boom time.
Albert Edwards of the French bank Société Générale was quoted in The Guardian article of 1-3-2011. He is a good example of independent investment advice. He said “…China is basing a growth model on the most unstable part of GDP. Something has to give – and probably sooner than most people assume. … In reality, China is a much more potentially volatile economy than people think. The Chinese situation is the one that could come out of nowhere because people are not considering it…. China has produced such strong growth for such a long time that investors assume the process will last indefinitely’…. "There is too much confidence in the lack of volatility.” End quotes.
These comments remind me of Nassim Taleb’s black swans. The comments support my opinion that China, as one of the three pillars of the world’s economy, will weaken and thus the world economy will go back into recession. Edwards also forecast the yield on UK Gilts would go from 3.5% to 2.0% and the stock market would retouch the lows of March, 2009, which is something I have been expecting. U.S. Treasuries would behave in a similar way. When China’s economy cools down then commodities will plummet and so will countries like Australia and Brazil that export commodities to China.
In today's Wall Street Journal an editorial said that China's lending exceeded quota by 40%. "Local governments and banks have set up off-balance sheet vehicles to conceal loans and keep the spending boom going."
This could explain China's overheated bubble economy. The article said it could go on for another year and thus the bubble will get bigger.
Since China is one of the three pillars of the world economy along with the shaky Eurozone and the U.S., which has a huge unresolved burst housing bubble, then this means all three pillars are unreliable and could get worse. My independent investment advice is that a deflation strategy is correct. This would imply one should do bond investing, and one should examine alternative investment advice for ways to weather the storm.
The real economy in many ways has recovered since the Lehman crash of September, 2008. So does this mean today's stock prices with SP500 at 1256 are justified and that the bear case is wrong?
Using the principles of independent investment advice, the best way to judge the market is with the Schiller 10 year average P.E. ratio, which is at 22.7, versus a norm of about 15; also after a bad credit crunch it should have declined to 12, which is a 47% drop to SP at 664. Further the dividend of 2% should be at the historical average of 4.3%, which implies SP must drop 47% to 664.
The world economy has three main pillars: U.S., China, Europe. In the U.S. the housing crash with a huge oversupply of contingent inventory and delinquent debt still has not been resolved, thus house prices will go down. In Europe even Germany is threatened by the potential for failure in the southern area of the Euro zone. In China there is the risk of a bubble that will end as all bubbles do, in a crash. The best that could happen in China is a growth slowdown instead of a crash which would result in the world economy getting less stimulus during a time when the rest of the world's economy is very weak.
The only reason for stocks to be so high is because of fear that they are the only haven from inflation (assuming investors don't like commodities, gold, etc.). But if inflation returns it is not a straight pass-through for stocks; on a "real" basis stocks decline during times of inflation. Also, if inflation hits then interest rates will rise which will absolutely hurt the stock market. During times when interest rates are low the bulls say that low rates act as a lever to make stocks go up, but when rates go up the bulls are evasive about that issue. So if we remove the investor's belief that stocks are a hedge against inflation and then a new series of U.S. and Euro area debt crahses occur and China's economy cools down then there will nothing to support an overpriced stock market.
originally published December 7, 2010 by Don Martin.
The Long Term Treasury ETF TLT declined 2.14% today because last night a “tax cut” (in reality an extension of a 9 year old tax law, and thus not a cut) will be approved by Congress and the President. There will also be an actual, but temporary, cut in payroll tax rates. One might be tempted to think this will magically cause employment to recover thus igniting inflation and killing the bond market. However, the big picture is that increasingly both China and the Euro zone are looking like a bubble that will (or already has) burst. Also, according to Barron’s two-thirds of the U.S. homes that need to go through the foreclosure process have not yet completed that. With the huge amount of excess debt that Americans need to pay off plus problems in Europe and future problems in China where will growth (which would hurt bond prices) come from?
According to a Dec. 6, 2010 article by Ambrose Evans-Pritchard in www.telegraph.co.uk China has had a 40% increase in its money supply last year which would require monetary tightening. This may cause a hard landing with big falls in commodity prices, EM bonds, EM stock, and Asian growth rates. Homes in China are selling for 20 times income; in Tokyo it is 8x, in U.S. 4.7 x.
The Euro area does not have enough money to bail out its weaker members. Do you think Germany with 85 million people is rich enough to bail out all of the non-British EU part of Europe with 440 million people?
So where is the growth and demand that will make the economy recover (which would thus hurt bond prices)? I think today’s drop in bond prices was a one day panic which may have been exacerbated by a sell-off in Muni bonds. Because new issues of Buy America Bonds won’t be allowed next month municipalities are now in a rush to issue (sell) more bonds this month; this selling makes prices go down because there is too much supply, which in turn can affect Treasury prices.