Posted by Don Martin on Fri, Dec 30, 2011 @ 02:37 PM
The stock market will go down in 2012 and stay down for years. The only reasonably safe haven (but not guaranteed) are cash and investment grade bonds. We are in a Japan-style Soft Depression that will last until the end of the decade. As the years go by eventually the truth will come out and people will realize the Keynesian pump priming does not work, and definitely can’t work when society is over-indebted. People will realize that the Fed’s Quantitative Easing can’t work and is counter-productive. When the truth comes out then the price of Put options, that are vital to the operation of hedge funds, will increase to prohibitive levels, resulting a massive selloff of equities by hedge funds. The losses to Brokers that lend to hedge funds will result in less leverage and even more selling pressure.
Eventually, at some point, prices will get so low that the economy will reach a clearing point where prices will be low enough to start a new stock boom. Until then, focus on risk adverse capital preservation even if you are forced to earn less than inflation.
The things investors need to wake up to and realize are:
*The world’s governments’ Keynesian pump priming can’t work in an over-indebted world.
*Inflating the money supply by Central Banks won’t solve our problems.
*The Euro currency is doomed and will lead Europe into a Depression.
*The Fed’s overstimulation of the past 15 years has created a huge bubble which can only be fixed by markets declining to low prices.
*Investors who sell uncovered Put options on stocks are as wrong as AIG was with the housing bubble.
*The housing market is a permanently busted bubble and is not coming back despite allegedly improved affordability ratios.
*It will take until the end of the decade to fix the unemployment problem which in turn is needed to create demand for housing and for goods and services produced by publicly traded companies.
*The world has an unprecedented amount of far too much debt
People wonder how to protect their 401k from a brokerage collapse. They ask if their 401k will be safe if their broker goes bankrupt. They want to know will the FDIC be solvent if the dollar is devalued. These are important topics to be aware of.
I wrote an article “Bear forecasts a bullish stock market”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Dec 29, 2011 @ 07:06 PM
From 2002 to 2008 Central Banks were net sellers of gold. During that time purchases of gold by ETF’s ranged from zero to 150% of the amount sold by Central Banks. From 2002 to 2008 the average yearly ETF’s purchase of gold was about a third of the amount sold by Central Banks. What is remarkable is the huge increase in purchases by ETF’s in 2009 and 2010 occurred when the gold price increased dramatically. In 2011 net purchases by ETF’s were only about 20% of the amount bought by Central Banks and gold’s price increased by 9.3%. The implication is that the huge price increases in 2009-2010 were due to a huge demand by retail speculators who bought gold ETF’s, which in turn implies that the price of gold is a bubble created by naïve speculators who chased the price way above its fundamental value.
Gold fell below its 200 day moving average on Dec.7, 2011. This was the first significant fall below the 200 day moving average since the Lehman crash period when markets plunged in late 2008-early 2009.
The best estimate for fair value of gold is to use its price in the early 1980’s when it spent a long time in the $400 range and then adjust that for inflation which would imply that it is now worth $1,200. However there are other methods of valuing gold that imply the fair value is a range of $700 to $1,000. I don’t buy the theory that because the money supply expanded due to the Fed’s QEI and QEII monetary easing that therefor inflation will increase in direct proportion to the increase in money supply; if that was correct then gold would be worth $2,400. In order for the increased money supply to cause inflation the banks would need to lend out those funds instead of hoard them. Banks usually lend only to well-qualified borrowers and those people usually don’t need a loan. The banks’ hoarded money is not really money since it merely an accounting entry that is parked at the Federal Reserve.
In the future I expect problems with the Euro will be deflationary which will put downward pressure on gold’s price. Also China’s growth rate may moderate resulting in less world economic growth and thus contributing to a less inflationary world, which would imply lower gold prices.
I wrote an article "Is gold fairly priced?"
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Dec 21, 2011 @ 03:01 PM
What were the best investment asset classes in 2011?
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Using Morningstar software I screened asset classses using a minimum return of 2% in 12 months and ranked by Sharpe ratio. Of these 340 asset classes the top ten were: GNMA mortgages, followed by three other Mortgage indexes, and a Barclays Universal Bond index. The ones ranked six through ten were: intermediate or short term bond indexes. (The indexes are hypothetical because you can’t buy them and in the real world they would have fees associated with them that would reduce their returns.)
An article in today’s FT said that mortgage securities have been priced too low in anticipation of an excessive amount of credit risk. One source was quoted as saying that mortgage bonds were priced as if the assumption was that half of all non-agency mortgages would become delinquent. These are often subprime mortgages or else huge jumbo mortgages that are too big for Fannie and Freddie, so that is not the same as the mainstream “A” paper Fannie or Freddie mortgages.
However, ranked only by highest 12 month return and ignoring risk, two of the top ten assets were precious or base metals indexes, and three were utilities stock indexes, one was a high dividend index, four were bond indexes. Assuming that metals are a possible bubble and have too much risk then it appears that bonds and utilities were the best asset classes, along with high dividend paying stocks.
I wrote an article “Refinance plan to harm mortgage investments”, however there are a lot of professional mutual fund managers who feel mortgage bonds are not likely to be affected by potential refinancing into lower rates, since many people can’t qualify or can’t justify the fees to refinance. I wrote "Bond bull market to continue".
The performance of the winning asset classes conforms to my bearish doctrine that this is the time to invest in investment grade bonds and avoid other asset classes, although the market disagreed with me regarding high dividend paying stocks. My response to that is that during the 1930’s dividends were 6%, not the 3% that the asset class of high dividend paying stocks have been paying. Also, very high dividends could be a sign that a company’s stock has dropped low in a “value trap” where it is going down to zero. Assuming PE ratios drop to 1930’s levels then we will have 6% dividends and people will see their stocks drop by 50% in value. So that implies one should not buy high dividend stocks now and should wait to buy during a crash like the March, 2009 low of 666 for the SP.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Dec 20, 2011 @ 03:32 PM
How does Newt Gingrich‘s campaign affect the market?
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Newt Gingrich’s presidential campaign success has threatened the ability of more reliable, well modulated Republican candidates to get the Republican nomination, thus increasing the chances of an Obama victory. This is a negative for the markets.
With some controversial Republican candidates running there is an increased risk of a deadlock and a stalemate in the Republican primary, which helps politicians who are opposed to market based economic solutions. These controversial, mercurial candidates are at risk of breaking away and forming a third party which would siphon off Republican pro-business voters thus handing victory to those who would oppose free enterprise. By contrast the more mainstream Republican candidates would never consider breaking away from the party.
The test for the candidates would be the Iowa caucus and New Hampshire primary. Iowa’s is not an election, rather Iowa’s is a caucus where people are pressed into reaching a consensus to pick a candidate in face to face town hall meetings. New Hampshire is next to Massachusetts where Romney was governor and that may help Romney to reduce Gingrich’s success. The equity markets could react more favorably once the New Hampshire primary has been completed.
Gingrich was correct when he criticized the formation of a Congressional SuperCommittee. I wrote an article “Super committee failure may lead to recession”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, Dec 19, 2011 @ 03:47 PM
How will the death of Kim Jong Il affect the markets?
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The death of North Korean dictator Kim Jong Il yesterday may result in political instability and more market volatility. If North Korea collapses it will be very expensive for South Korea to solve the North’s problems. This could result in a recession in South Korea which could spread to the rest of Asia. Over the long run it will make the Asian region more productive and reduce inflation as North Korean workers become part of the global work force.
The risk of political instability helped drive more investors into U.S. Treasuries today with the Treasury long bond ETF “TLT” going up 1.27% to close at 123.87, its highest closing price ever. However, I think this was due to fear about the continuing crisis in the Eurozone. Remember the collapse of the Soviet Union and east Germany? The changes in China? The collapse of the South Vietnam government? These changes may inspire fear but in terms of how they affected the world economy it was not that significant except that it increased the supply of low cost labor leading to a deflationary boom. So if 20,000,000 North Koreans join the rest of the world it won’t change the world economy that much.
The real news story is that the bond market is getting worried about a Eurozone collapse and continues weakness in the U.S. economy, thus making Treasuries go close to new lows.
I wrote an article “Don’t worry about the stock market”.
Investors should seek independent financial advice. 
Posted by Don Martin on Wed, Dec 14, 2011 @ 05:01 PM
Today’s market crash warns of future crashes
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Today’s market crash indicates the bear market trend will continue. The SP was down 1.1%, gold down 3.5% to rest at a key support level – if that breaks then be prepared for a big drop in gold. Copper is down 3.8% today, the Euro is down 1.4% breaching a key support line of 1.30. The DXY index (showing the dollar compared to other developed countries) is, at 80.5%, only 0.5% from breaking a key upward barrier.
The big thrill of investing for the bulls has been either commodities or Emerging Markets. But China’s boom, which could be exaggerated and due for a crash, was the reason for the EM commodities boom which in turn boosted EM stocks of all types. So if China crashes or merely cools down to a normal growth level of 3% then the EM commodities and stock boom will cool off and the hyper leveraged developed country speculators who play the commodities markets will panic and sell off their commodities.
Thus it is too early, by several years, to assume that EM currencies will beat developed country currencies. This will instead happen during the coming boom of the next decade. I expect world equities to be in a bear market until the end of this decade. This will be verified once the Euro crisis reaches the bottom and China’s boom cools off.
What was the safest investment during the 2008 crash?
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People wonder how does the economy affect a 401k? They ask about 401k changes if the Euro crashes. They want to know are 401K’s safe from MF Global type of problems. The safest place for a 401k, or any account, is to hold dollar denominated high quality investment grade bonds held in a mutual fund.
I wrote an article “Three bear market strategies you must know”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, Dec 12, 2011 @ 05:16 PM
Since December 2007 the work force declined by 53,000 but the population expanded by 9,000,000. This is the longest period in the past sixty years to get near to the employment high point of the period before the current recession. Bloomberg BusinessWeek said if the work force had grown at its normal pace the jobless rate would be 11.4% instead of 8.6%.
The employment to population ratio has barely budged during the recovery from the lows of March, 2009.
This implies that an additional three percent of the population are a part of the hidden discouraged unemployed. The U-6 unemployment rate that counts hidden discouraged unemployed is about 16%.
With wages stagnant and unemployment needing another nine years to return to normal that means we are in a Japan-style Soft Depression which means low Treasury bond yields are legitimate. This implies that one should avoid equities and real estate and other “risk assets” until their price has dropped to a secular low like that of March, 2009.
People wonder what to do to protect their 401k. In addition to picking the correct investments and keeping fees low another risk for 401k investors is that if they become unemployed they can’t contribute to their 401k. If they borrow from a 401k they can’t contribute to the 401k until the loan has been repaid. So unemployment and underemployment are also a threat to 401k’s.
I wrote an article “Jobs report confirms bond bull market”.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Dec 09, 2011 @ 02:51 PM
Eurozone crisis problems have not been solved
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I posted in article in Forbes about theEuro crisis on December 8 "Euro crisis will only get worse and do serious damage to investors".
Early this morning in Europe the Eurozone leaders agreed to a new series of agreements that will require more central control over the member countries' budgets. The main effect of the agreement is to move towards austerity. It won't help much with raising funds to stop the run on sovereign debt. So unless the ECB agrees to do massive money printing to buy up decling sovereign debt then this problem will go unsolved and worsen.
The news media hinted before this meeting that it would provide some radical new solution that would solve the Eurozone's problems, but the solutions presented seem weak and uninspiring. Eventually investors will realize that this is not bullish news for U.S. stocks; rather it is bearish due to the inability to solve a growing problem.
An interesting idea is that due to the Eurozone's problems investors will flee to the U.S. and due to low interest rates they will simply buy dividend paying stocks to get a 2 to 3% dividend, thus pushing up stocks. In theory this could be true, but it would be wrong from a standpoint of logic becuase eventually when the truth comes out stocks will go down and investors who compared them to bonds will get mad at sell when there is too much volatility. So the possibility of an inapproriate U.S. stock rally means that if that happens that it would merely be a false signal caused by emotions.
An analogy to that would be when the great recession of 1990 began in Japan interest rates were lowered which caused people in Japan to get excited and buy more Japanese real estate causing a brief real estate rally. But eventually prices came way down and stayed down.
Investors need to weigh the intrinsic value of a business and not merely look at momentum buying by investors who made an incorrect emotional leap of faith.
I wrote an article "Euro crisis to damage 401k's" and "Two things you must know about Euro crisis".
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Dec 08, 2011 @ 09:21 PM
Objective Independent Financial Advice is Key to Winning
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The importance of independent financial advice was demonstrated to me today when I attempted install a wireless access point at home to replace my land line DSL internet access. I got bad service from vendors who failed to think in an objective way about the big picture regarding my needs. Instead these self-centered, myopic vendors failed to ask the right questions and glibly told me the components were compatible. After a long and painful experience finally some of the vendor’s employees confirmed that there was an incompatibility issue and said to get a refund. This could have been prevented by training the reps to tell customers to check their hardware against a compatibility chart. I asked the sales clerk about compatibility and they assured me it was compatible based on intuition without bothering to review a chart. I am very displeased at the waste of time by these inefficient and thoughtless employees.
This reminds me when I had ATT DSL at my office and had bad service that kept getting worse over several years from about 2008 until I got rid of ATT in 2011. The employees claimed to be motivated to help me and kept finding “solutions” but the “solutions” and diagnosis were bogus. ATT employees who examined the line remotely assured me that nothing was wrong. After four visits to my office finally a technician said the only way to diagnose it was for him to drive to a repeater box that repeats the DSL signal from the phone company office. There he found evidence that I was simply too far away from the phone company office to get good DSL and so I was told to order a slower version of DSL. This took years to be diagnosed properly. Also ATT had earlier insisted that buying their modem would solve the problem but that failed soon due to overheating. Instead, my old modem bought eight years ago worked fine. I found some free advice on a website that was created by an independent consultant who explained that the new modem recommended by ATT was a defective one.
The bad service was because of the corporate culture of a giant company that only cares about pushing products. The thing that they should have done was to say right at the start several years ago that the problem was caused by being too far away to get DSL and that I should use a competitor that offered cable. Finally I got cable and great service! (To be fair, regarding today’s home wireless installation I was actually helped correctly by ATT, but my office telecom needs were far more important).
Years ago I was trained in sales that one should admit to the prospect that the product is incompatible (if that is the case) and recommend going to a competitor rather than sell a bad product and make enemies. But these giant corporations seem to have forgotten that. Certainly that is true with Wall Street’s hustle of overpriced, poorly performing investment products.
The time wasted by me due to non-objective vendors is wasted money
So today’s tech frustration actually cheered me up: I realize the world needs the objective advice and expertise of small independent businesses (like fee-only advisors such as myself) to protect the client from ruthless manipulation by giant corporations.
This incident not only reminds me of the importance of independent advice, and it reminds me of the fact that 401k’s may have less independent financial advice because they have limited choices that are dominated by the 401k Custodians who may try to herd people into in-house mutual funds instead of allowing people freedom to get independent financial advice. I wrote an article “Six things you must know about 401k risks”.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Dec 07, 2011 @ 07:00 PM
In today’s Wall Street Journal Burton Malkiel writes that investors should refuse to buy U.S. Treasuries and instead should buy Muni bonds, foreign bonds in countries like Australia that have better finances, and dividend paying stocks.
The reason I disagree with his recommendation to buy Munis is because they have credit quality risk that does not make them comparable to Treasuries. Also they have the risk of being refinanced into lower rates whereas Treasuries are non-callable (no prepayment allowed). Munis are thinly traded and subject to expensive Broker-Dealer markup-Markdown costs that are opaque and difficult to judge.
Australian bonds have the risk that if China’s economy cools then Australia will suffer a severe recession due to a drop in China’s demand for commodities. Some houses in Australia cost nine times what they cost at the beginning of the commodities boom a decade ago. So Australian bank bonds, mortgage bonds, etc. will be of poor credit quality during a commodity bust. The Australian crash will hurt the credit quality of their bonds making them go down in value.
Dividend paying stocks including utility stocks are not comparable with bonds and are not a substitute for bonds. Stocks have business risk that can result in dividend cuts or even bankruptcy. There is no such thing as a risk free utility stock. Remember Enron, or PGE? Remember the old ATT that lost a huge amount of money due to competition before being bought by SBC? What if electric power companies are required to meet tougher Green mandates that destroy their profits?
The idea that stocks are a “pass-through” for inflation “making the stock perhaps even less risky than the bonds” is wrong. During inflation people become poorer and react by reducing purchases, switching to lower cost (lower profit) vendors. Stocks don’t always go up with inflation. During the 1965-1981 inflation era stocks made no net price gains while the Consumer Price Index went up several hundred percent.
Stock bulls claim that low interest rates help act as a lever to raise stock prices, so that implies during a period of inflation interest rates will rise, increasing the discount rate for stocks and thus decreasing the price of stocks. Using stocks with a 3% dividend as a substitute for bonds is a dangerous game because the past twenty years the Fed has engineered an easy money bubble that has unjustly inflated stock prices beyond intrinsic value. Stocks can and will drop suddenly and mercilessly to a more reasonable value around 800 for the SP, a 37% drop and stay down for a long time.
Avoid getting only this coin back from your investments
The purpose of bonds is to act as a safe haven rather than place to make a windfall. The haven is supposed to have minimal downside risk and thus can be liquidated during a stock crash and then used to buy stocks at low prices.
The way I could be wrong would be if I misjudged the recurrence of inflation and had too much in long term bonds. So one should be vigilant against inflation and maintain a bond portfolio with a duration that is medium to short term based their risk tolerance.
I understand that if we had a repeat of the 1970’s inflation then long term bonds would be badly hurt. Regarding inflation, in the past 220 years the only U.S. peacetime decade of significant inflation was in the 1970’s and that situation is unlikely to repeat. Instead, a Japan-style Soft Depression is the greatest probability. This would mean “risk assets” including the ones recommended by Malkiel will go down and Treasuries will go up in value.
I wrote an article “Bond bull market to continue” and “Unemployment rate actually worse”.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Dec 06, 2011 @ 02:46 PM
Goldman housing bottom call is wrong
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The FT had an article about Goldman Sachs call for a housing bottom in 2012. The Goldman report is wrong. Believing that housing has bottomed will lead investors into thinking it is time to buy stocks. Equities are overpriced by 40% and due for a crash. The report did a good job of breaking out some of the reasons for appreciation but failed show that the abuse of “Alt A” or “Liars loans”, not subprime, was the key marginal factor in causing a housing bubble. Now that lending is “full-doc” only and unemployment is high we would have to go back to the 1982 recession (when there were no easy qualifiers) to find a similar era to compare things to. Worse, the massive debt of all types that consumers are liable for means that they need to do some deleveraging (paying down of debt). So they need to buy a smaller house. If most people are selling and down sizing then who will be upsizing to offset this downward pressure?
The financial establishment continues to use broken metrics comparing house prices to rent or personal income or whatever, but those metrics are not applicable because the use of “easy qualifier” liar’s loans since 1984 to 2009 created a massive bubble, so we can’t return to that era.
The most important factor in buying a house is the ability to get a mortgage and that is mostly influenced by one’s income. Income must be measured on a two year average for bonus, overtime or self-employment. Due to layoffs, recessions, etc. many people who make good income can’t use 100% of their income for a loan because the qualitative nature of their income is too shaky for a bank to recognize it. I never see this topic mentioned by these scholarly establishment reports about the housing market. Instead I see over-simplistic metrics about affordability, but the bank doesn’t care about those metrics because they judge a borrower by qualitative and quantitative analysis of his income.
Open the secrets of the economy
America’s labor force in 30 years has evolved from salaried to self-employed, commissioned, independent contractors and as such those people may not qualify for a loan even if they make good income due to the two year average rule or the rule that income must be stable and the rule that a secondary job for person working at two jobs, is not counted unless one has been doing both jobs for two years. As a nation we have become poorer than we think we are because a true measure of income should include all the fringe benefits including pensions that Corporate America took away from workers and it should include a risk assessment factor that discounts the value of volatile self-employment income. Of course some self-employed highly skilled dual major professionals such as internet marketing consultants, engineers, attorneys, CFO’s are better off than in previous decades but they are mostly clustered in a few upper class neighborhoods.
On an inflation adjusted basis personal income peaked in 1998 and has gone down significantly since then. If you adjust that for a figure that discounts the unreliable nature of non-salaried income then it is even worse. The housing bubble really took off in 1997, so that seems like a good baseline for prices to fall back to. In addition, the easy qualifier loans available during the early years of liar’s loans from 1984-1996 were somewhat strict about screening out the liars, so home prices before 1997 were less influenced by liar’s loans.
During the 1984-1996 era banks required easy qualifier loans to have a very large non-gifted down payment, a telephone verification of employment with a job that made sense for alleged income listed on the loan application. Only owner occupied single family homes could be used for these loans. Only people with near perfect credit could get them.
Consumer debt of all types exploded after 1998. I used to think this was justified by the booming tech industry (just like the 1950’s propaganda by the nuclear power industry claiming someday in the future nuclear power would be so cheap that would result in unmetered home electric service). But in reality the over-consumption of debt since 1998 was due to a drop in consumer’s income and part was due to consumer’s speculating in real estate to make up for less earned income. So to find an appropriate benchmark that we can compare housing to we need to go back in time to an era when the total amount of consumer debt was more reasonable, as well as when there was less abuse of easy qualifier mortgages. That points to sometime before 1998 or 1997. To exceed those 1997 prices means we need to repair the unemployment problem and make the job market as good as it was during the 1998 tech boom, which is a ridiculous dream for rest of the decade.
I wrote an article “Home price to income metrics wrong”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, Dec 05, 2011 @ 03:10 PM
Roth conversion season requires tax planning
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Roth conversion season is here. You can convert a traditional IRA to a Roth IRA anytime but most people prefer to do it close the end of the year so as see how it will impact their taxes. If someone has less than normal income it may be a good year to do a Roth conversion because they are in a lower than usual tax bracket. Even if someone is in the maximum tax bracket it may still be a good idea to do a Roth conversion because in future years tax rates will be higher starting 13 months from now in 2013.
There is no way to know what is the best way to decide how much of a traditional IRA should be converted to a Roth because futures changes to the tax code are unknowable. If someone was in the 15% tax bracket and thought their lifetime average of income was going to be in the maximum tax bracket then of course it would make sense to do a Roth conversion for an amount that would not push their taxable income into significantly higher tax brackets. But what if someone is a steady income earner who anticipates a reasonable income in retirement and feels his annual income will not change that much. What strategy should that person do for Roth conversions? The answer maybe “tax diversification” which means to diversify assets into different tax strategies: put some in a Roth, and some in a traditional IRA. I have never seen a clear, convincing article or white paper justifying why someone should use a particular strategy.
One argument in favor of Roth’s is that they have no Required Minimum Withdrawal. Another is that they allow early withdrawal with no penalty if the account has been in existence for over five years. But it would a bad idea to do a withdrawal from a Roth.
Don't pay too much taxes with an incorrect Roth conversion strategy
One CPA said there could be a national sales tax, so he asked, why bother to contribute to a Roth? But I doubt the income tax would be repealed for upper-middle class people and replaced with a sales tax.
The problem with Roth conversions is that they require cash to pay the tax and the cash can’t be taken the account unless the tax and early withdrawal penalty (if under age 59.5) is paid. The taxes paid now for a Roth conversion could have been left in a traditional IRA and allowed to compound for many years.
Related to having an IRA is the topic of 401K’s. I wrote an article “Three things you must know about protecting your 401k”. You can roll your IRA into a 401K if your employer allows it. That might be unwise, since you have more freedom to invest in an IRA. But a 401k allows penalty free withdrawals at age 55 if one becomes unemployed after the first day the year a person turns 55. A 401k allows a five year loan; an IRA only allows a 60 day temporary withdrawal.
An IRA is an "Individual Retirement Account", so you should should seek independent financial advice. 
Posted by Don Martin on Fri, Dec 02, 2011 @ 07:35 PM
I have published today a blog post on Forbes about avoiding Eurozone risk with domestic investment grade bonds. GNMA bonds have less risk than other mortgage bonds and offer a reasonable yield. I also wrote a post "Bond investing during low rates".
Today the bond market was up 1.4% while the SP was down by 0.02%. The 30 year Treasury ETF "TLT" is above its 50 day moving average and continues to stay within bullish chart trendlines.
The Fed's swap lines, announced on Wednesday, with the ECB are for a very small amount and were already established. All that happened was that the rate was cut. But cutting rates for four years has not revived the economy. Why should an extra 50 basis points cut make a meaningful difference? The only cure for Europe is for the bond issuers in the PIIGS countries to default which will make the German and French banks go bankrupt. Then the European taxpayers can pay to bailout their banks.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Dec 02, 2011 @ 02:35 PM
How should people invest during periods of extreme volatility?
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During the boom of 1987-2000 whenever the market encountered volatility Greenspan would ease monetary conditions thus leading to “Moral hazard” where investors felt there was a “Greenspan Put option” that would keep the market from going down. The perception of a no risk one-way bet and lots of cheap, plentiful borrowed money resulted in people overpaying for stocks and creating a bubble that has gone on for over 16 years. Now the Fed is desperately seeking to create a new bubble because Congress won’t authorize massive deficit spending to stimulate the economy.
The fundamental theme is that the markets have been propped up for over a decade and they need to go down to reach fair value. In addition the markets for risk assets have become highly correlated, especially during a crash. (If you only want to sell during a crash and correlations rise close to 1.0 during a crash when you try to sell then you have no diversification. Instead you have “di-worse-ification”.)
The normal rules of investing are not applicable during an era where the government is trying to create a bubble to reinflate the economy and where people are massively overburdened with debt. One of the myths of investing is that crashes are temporary things that last a year and all you have to do is wait a year for people to forget and then the market will resume its upward trajectory. But every 80 years there are depressions that last a decade or more. The current depression may not end until 2017 or even 2019. During a depression people assume that any dip is a temporary buying opportunity, only to find out later that the market was still overpriced and unstable.
Investments should be in conservative, low volatility, high quality assets. The lowest volatility assets are short and intermediate term investment grade domestic bonds. You may be tempted to say that they only pay two or three percent yield net of mutual fund fees and conclude that one might as well buy high dividend stocks that pay around 3.3%. But dividends can be cut if the company over-expands or otherwise gets into trouble. Bonds have priority over stockholders. Bondholders must get paid first before stockholders. I remember new clients in 2005-2006 used to boast to me that they owned stocks like B of A with a 4% dividend, while the SP had a 2% dividend. I tried to warn clients that banks are very risky and that a dividend can be cut. Look what happened: B of A trades for 10% of what it used to be trading at and dividends were cut to almost nothing compared to that of 2006.
The favorable tax treatment of dividends and low long term capital gains taxes is a temporary feature that will soon go away in 13 months and there will be a surtax on investment income to pay for health care assessed against couples making over $250,000, which is not that much income for Silicon Valley.
How to allocate assets in this climate
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So avoid stocks, REITs, real estate, below investment grade bonds and other risk assets until investors come to their senses and realize that the economy has been in a bubble since 1995. When the truth is accepted then stocks and other risk assets will crash like in March, 2009. Diversification is less relevant than in normal times because risk assets are all overpriced and their correlation rises when the markets crash just when you want to sell. Instead, focus on the asset class of conservative, low volatility, high quality assets. The lowest volatility assets are short and intermediate term investment grade domestic bonds. Of course, I am open to the idea that I could be wrong, so some diversification into other asset classes is OK. But if you go into risk assets then at least, in those asset classes, try to get the least risky Emerging Markets bonds, or the least risky high quality large cap domestic stocks. Recognize that risk assets will encounter periods of high volatility and could end up failing, meaning filing for bankruptcy. For example, remember, MF Global was able to get the Fed’s permission to be a “Primary Dealer” which is a rare honor bestowed only to a few special Dealers who get special access to the Fed. The credit rating agencies did not make a significant rating downgrade of MF Global until a few days before the bankruptcy
On Wednesday November 30 I wrote an article “Today’s rally was a setup to failure”.
Investors should seek independent financial advice.
http://www.mayflowercapital.com/blog/bid/73263/Today-s-rally-was-a-setup-to-failure-Independent-Financial-Advice
Posted by Don Martin on Fri, Dec 02, 2011 @ 11:10 AM
Today’s nonfarm payroll unemployment report
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The government released the monthly unemployment report. It said jobless rate decreased from 9.0 to 8.6%. However, the employment to population ratio is a more meaningful number at 58.5 it was only up 0.1%. Average hours worked was up only 0.1%, and wages were down 0.1%. If wages go down then simply increasing the number of jobs won’t heal the economy.
The most important thing is that the 120,000 increase in jobs was less than the 200,000 needed to keep up with population growth, so the “real” population adjusted change in jobs should be seen at negative 80,000. It is analogous to when people look at interest rates they should look at the “real” inflation adjusted rate and not the nominal rate.
The bond market tends to be more rational than the stock market. The 30 year Treasury bond ETF “TLT” is up 0.81% this morning, so the bond market thinks the jobs report is bearish for stocks and bullish for bonds. Treasuries are above their 30 day moving average.
I wrote an article “Important data to be released Friday”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Dec 01, 2011 @ 01:55 PM
How will tomorrow’s non-farm payroll unemployment report affect the market?
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Tomorrow the unemployment rate will be published. The rumor is at 125,000 new jobs will have been created. The country needs 200,000 net new jobs to accommodate population growth, so in that case in “real” terms jobs will shrink by 75,000 in tomorrow’s report. This is bearish. I feel confident the Fed’s action yesterday to loan funds to the ECB will not work, will not solve the Eurozone’s problems and will soon be forgotten by the market. Risk assets will go down.
During the past two quarters consumers dipped into savings, which is unsustainable, to pay for expenses. And this is during a time when the payroll tax was cut by 2% saving thousands for some two income couples. That tax cut ends in 30 days. Also ending in 30 days are many stimulus programs. The ability of China to restimulate their economy is less than in 2008 because of the debts they have accumulated, and that is the same in almost the entire world except for a few small countries like Sweden, Norway, Singapore, etc.
Stocks and other risk assets are overpriced, overleveraged, and propped up by very low cost margin money and by the availability of Put options which serve to encourage hedge funds to buy stock with huge leverage. It is a house of cards that will come tumbling down in a flash crash.
The Fed’s loan the ECB yesterday was not news! These swap lines already existed. All that happened was that they price of borrowing was cut. If you loan money to someone who can’t pay it back then you have made the problem worse by postponing it and letting it get bigger. It will encourage European governments to settle for insufficient measures to solve their economy and thus no progress will occur.
Open the secrets of investment wisdom
How to allocate 401k during the European crisis
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People wonder what is the safest investment for 401k, what are the best ways to safeguard 401k against a crash, how to protect your 401k, what is the safest place to put your 401k money. Instead of chasing after the highest returns, consider focusing on investments with below average risk such as short term and intermediate term high quality investment grade domestic bonds held inside of a mutual fund. Of course that recommendation could change suddenly. For example several years from now inflation could come back and hurt bonds and one never knows when inflation will come back. Also credit quality deteriorates during economic crashes so even non-Treasury bonds can go down in value during a recession if the fear of credit quality overwhelms the investors’ desire for the relative safety of corporate bonds.
Yesterday I wrote an article “Today’s rally was a setup to failure” and “Euro crisis to damage 401k’s”.
Investors should seek independent financial advice. 