Posted by Don Martin on Thu, May 31, 2012 @ 07:40 PM
I attended the Financial Planning Association’s annual NorCal conference in San Francisco on May 29-30. The conference was excellent. Michael Kitces gave a talk about the Safe Withdrawal Rate (SWR). This is the amount that a retiree can withdraw from his assets each year in order to make the assets last for 30 years of retirement while getting an annual spending increase for inflation. It attempts to be strong enough to survive the worst bear markets in 150 years. Of course there is no guarantee that past market performance is indicative of future results and no guarantee that a withdrawal method is truly safe.
This topic has been researched by Bill Bengen and Jonathan Guyton and others. Bengen started with a 4% safe withdrawal rate and has since changed it. Guyton advocates a higher rate based on client willingness to cut spending when a portfolio is not doing well. Based on changing several factors there is a blend of SWR that can go up to 7%. These factors include diversification, a higher equity allocation, ability to generate alpha, small caps, willingness to be flexible and cut down spending during bad times. SWR assumes all assets are spent down in 30 years of retirement and that the client gives himself a modest annual raise for inflation.
The problem with market returns is if low returns are received in the early years of retirement then a portfolio never recovers from the cost of withdrawals. One must be prepared for the misfortune of the first decade of retirement to occur when rates of return on investments are low or negative. The sequence of good versus bad returns is crucial to the outcome over 30 years.
This should be looked at on a “real” inflation adjusted basis. Surprisingly depressions are not so bad because of the lack of inflation diminished the problems of being an affluent retiree; it is the era of inflation in the 1970’s that really hurt retirees. Losing money through stock market crashes is more of a problem than being too cautious and missing the tops of the equity market because an investor sold too soon during a bull market.
How much of your nest egg can you spend down during retirement?
My opinion is that the SWR can be heavily influenced by avoiding stock market bubble tops and by buying at generational bottoms with assets that were protected because they were held in low risk assets like investment grade bonds. During the 1970’s inflation stocks didn’t protect retiree investors from horrendous inflation. During the Great Depression a new retiree never recovered from the bad sequence of heavy losses early in retirement. To survive the Depression one should have avoided the bubble of 1929. To survive 1970’s inflation one should have considered alternative assets to fight inflation instead of naively and incorrectly assuming that stocks are a “pass through” for inflation.
I posted an article by the FPA “Retirement planning” that discussed the SWR.
Investors should seek independent financial advice. 
Posted by Don Martin on Thu, May 31, 2012 @ 02:20 PM
I attended the Financial Planning Association’s annual NorCal conference in San Francisco on May 29-30. The conference was excellent. Dennis Stearns gave a lecture explaining that the economy will do well because of unleashing of new disruptive technologies and demographic trends that favor the U.S. over China and Europe. The talk was very inspirational. However, we have heard this song before that technology would magically induce huge rates of growth and the economy will boom. Maybe it will happen, but it may happen so slowly and so far in the future that today’s bubbly stocks prices, which need to go down, will still go down first to a fair value before they can resume their upward movement in the future.
New technology will solve everything. Yah, right
I think the way a new tech revolution would play out is that it would raise the overall GDP and the value of all stocks but surprisingly many tech stocks would not provide outsized returns and when one averages in the tech stock losers with tech winners the tech stocks as a group may do no better than generic non-tech companies, especially on a risk-adjusted basis. Also tech stocks like Facebook went IPO at overpriced levels which mean that retail investors can’t participate in the Tech sector since buying an overpriced stock is not a meaningful way to participate in an investment.
I wrote an article “Will tech crash lead to stock market crash?”
Investors should seek independent financial advice.
Posted by Don Martin on Thu, May 31, 2012 @ 12:31 PM
The jobless rate in tomorrow’s monthly employment report should show 133,000 new jobs based on my sources. See the good article in New York Times about employment rate. After adjusting for population growth of 125,000 a month the “real’ job growth rate will be close to zero. The average growth has been 150,000 a month for the past 12 months. The growth in winter was skewed by the extremely warm, dry winter, so in “real” terms adjusted for weather the job growth for the past 12 months was probably 120,000 monthly and if that figure was adjusted for population growth then there was a tiny loss of jobs in the past 12 months. And this is despite massive stimulus and tax cuts. Also much of the job growth has been low wage service jobs that have suffered pay cuts. This is deflationary, which explains why the bond market today reached record low yields.
Access the secrets of economics
Since home buying is constrained by the ability to get a loan which is constrained by employment and income then expect home values to stagnate. The exception is for homes located near Silicon Valley or Manhattan or Washington,DC where there are lots of good jobs.
The Treasury bond market has already anticipated and priced in the coming recession, however the economy could get worse than the bond market's forecast, making Treasury yields even lower.
I wrote an article “Record low Treasury interest rates today” and “Bond bull market to continue” and “7 things about deflation you must know”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, May 31, 2012 @ 11:11 AM
The bond market experienced record low interest rates today with the ten year U.S. Treasury yielding as low as 1.53%. Other major AAA quality sovereign bonds are yielding even lower, for example German’s 10 year Treasury is at 1.26%,Sweden’s is 1.3%. This is truly a historical moment. This is not caused by the Fed’s manipulation; rather it is caused by the bond market deflation vigilantes who are much more powerful than the bond market inflation vigilantes. The bond market for investment grade bonds tends to be so boring that only cautious, objective professionals are motivated to get involved and make an impact in the market, so it is a true free market way of letting the market forecast the future. (By contrast equities markets are dominated by irrational investors so that market sends out numerous false signals). The forecast the bond market deflationary vigilantes are giving is recession and deflation. Also Emerging Markets equities have gone down about 24% from their recent peak in April, 2011 and commodities like copper have gone down 11% in one month.
Open your mind to new viewpoints about bond prices
The problems with southern Europe are very bad so the world’s investors are seeking to flee into the safety of U.S. Treasuries and northern European Treasuries. The problems with Japanese Soft Depression have not been solved so investors need to avoidJapan.China’s real estate and capital improvements sectors also need to cool off which will be deflationary as property speculators suffer from a drop in property values. So the whole world needs to pile onto sovereign debt from a handful of countries like theU.S.,Germany,Sweden, but only theU.S.has a wide, deep Treasury market that can handle this demand.
I wrote an article “Bond bull market to continue” and “7 things about deflation you must know”.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, May 30, 2012 @ 05:57 PM
Mutual funds make a taxable distribution at year end of their profits from their “realized” capital gains. During the top of the market cycle mutual funds may have large amounts of low basis appreciated stock and when a crash comes then investors redeem their mutual fund shares, forcing the fund to sell appreciated stocks which triggers a taxable distribution. So when a bubble top bursts then the stocks held by a mutual fund go down and at the same time capital gains taxes maybe incurred. If an investor recently bought a mutual fund at the top of the market and refuses to sell then he will get stuck with the tax bill for gains that someone else enjoyed and he will see his shares go down in value – thus he loses twice! It is urgent because of the coming crash of 2013 or late 2012 for investors to sell equity mutual funds now both for tax purposes and to protect against stock values going down. If you own bonds, assuming my forecast is correct, bonds will go up when stocks go down, so bond investors who use bond mutual funds will not have this problem during the coming stock crash. (Of course in a few years bonds may crash, so don’t hold them forever).
This tax problem makes it important to avoid owning overpriced equities during a bubble top. Always consider selling perfectly good equities if their market price is artificially high and then buy them back during a crash.
The good news is that this is not a tax problem for retirement accounts, it is only a concern for taxable accounts. Your 401k won't incur this tax problem, however 401k's will be hurt because of the downward pressure on stocks prices which will be made worse because of the actions of investors (who have assets in taxable accounts) running for the fire escape.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, May 29, 2012 @ 09:51 PM
Would real estate held in 401k be a good investment during a devaluation?
If the dollar were devalued would that make real estate go up or down? It is tempting to think that if the dollar was devalued that foreigners would rush in to buy real estate thus making the price go up in local dollar terms. If a currency is devalued then that may induce a period of low interest rates which will help increase the value of real estate (if people believe the currency has become so undervalued that no more devaluations will occur and if foreign funds flow into the U.S.to buy low cost things). A devaluation would help move toward a full employment economy which would help real estate go up.
Will the dollar be worth as little as this coin during devaluation?
However, if investors believe that a country will be perpetually devaluing its currency then the country’s interest rates will need to rise to higher than normal levels to compensate for that risk. If interest rates rise suddenly to very high levels then that will kill off the real estate market. Most real estate is financed by debt and much of it is adjustable rate loans, so a sudden rise in interest rates could be a problem for real estate values. Also commercial real estate even if bought for cash attracts investors when bond yields are low, so if bond yields go way up then new buyers of real estate may think they can make more by investing in bonds, assuming they think that interest rates have peaked and stabilized.
The crucial valuation component of real estate is the rental cash flow. If a devaluation of the dollar occurs the tenant will pay the landlord with devalued dollars and the building’s cash flow will not improve (in international currency terms) and thus it is possible the building will not go up to match real estate values in other countries.
A gigantic mistake would be for real estate investors to use a mortgage denominated in a foreign currency because after a devaluation then the loan balance principle payments would be dramatically higher. This happened recently in Hungary when borrowers used Swiss Franc loans and when the Forint was devalued the borrowers had to pay the loan in expensive Swiss Francs.
In general, a currency devaluation stimulates the economy and will make depressed real estate go up because it creates jobs that enable people to afford to increase their demand for more real estate.
During the coming global recession I expect Europe to be depressed and to do a devaluation of their currency and America will be a relative value safe haven thus funds will flow into the U.S., making the dollar go up. In anticipation of this it has already started. The coming devaluation of Greek currency after they leave the Euro will produce a chance to buy their real estate at a discount. The idea of buying real estate after a devaluation makes more sense if the local economy is dependent on cash based purchases rather than adjustable rate mortgages. If the U.K.devalued, since they are dependent on rapidly adjusting adjustable rate loans, then their interest rates could go way up making their real estate unaffordable, thus permanently pushing down their real estate values. Perhaps a hedge fund could short U.K. real estate and go long Greek real estate, but only at the right time and probably it would be imposssible to hedge these two trades or to do it at the same time.
If an investor holds real estate in a 401k that is risky because they are many tax traps, including lost tax savings opportunities, associated with that. It is far better to hold rental real estate outside of a retirement account.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, May 28, 2012 @ 02:27 PM
Let's remember and be thankful for the sacrifices of our soldiers that have enabled the U.S. to be free. Our culture of freedom and respect for individual rights has been made possible by the sacrifices of our servicemen and serivcewomen.
The culture of freedom and respect for individual rights is needed to create a platform for the rights of businesses and investors to operate efficiently without being oppressed by those who would take away the rights of the person who earns money to develop his business and financial health. In many countries investors lack freedom from unreliable, oppressive governments and are forced to send their capital overseas to protect it. This makes their country poor and enriches safe haven countries that respect individual rights.
Here in Silicon Valley I have seen immigrants arrive penniless and become wealthy. There is nothing like this elsewhere and it is the U.S. culture of respect for individual personal and property rights that has been the key reason for this prosperity.
Posted by Don Martin on Fri, May 25, 2012 @ 10:02 AM
Facebook’s Business Loyalties Reminds me of Brokers Versus Fee Only Advisors
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I have criticized Facebook’s business plan and ability to grow its profits to justify its share price. However, the founder Mark Zuckerberg is very admirable. He said “Move fast, break things” as a metaphor. This is a symptom of a vital entrepreneurial spark of talent that is missing in older companies and is certainly missing in Europe and Japan.
Peter Drucker said that marketing and new technology are the only two things that give a company a competitive edge, all else is simply low margin commoditized activities with ever shrinking profit margins. To beat commoditization one must (as Zuckerberg said) “move fast, break things” in order to find either new technology or new markets.
There is no guarantee that Facebook will find a viable business plan which will be needed to make the profits grow five times the current level to justify the current stock price of $33 (assuming a mature business should have a PE ratio of 15). The Facebook IPO was only a week ago.
Ultimately this tech boom in Silicon Valley will burn out resulting in a surplus of unemployed tech workers as it did in the 2001 tech bubble. However the good news is that all the learning experiences of Facebook employees writing code and designing features will help to make the tech industry and its clients become more profitable after a tech crash when huge numbers of unemployed tech workers find jobs in other industries and other parts of the country.
Assuming that Social Media is greatly overrated and is an unsustainable and unworkable business plan then in a year or two the employees of those companies may be writing code for some completely different industry. The benefit of the current tech boom is that is inevitable burnout produces new opportunities for things not yet discovered.
The core of Facebook is the ability to sell ads to Fortune 500 companies that control 75% of the economy, instead of selling petty ads to tiny businesses. But the Fortune 500 are not youthful Social Media idealists, they are cold hard calculating non-idealistic people who insist of proven metrics of successful use of ads. Recently GM ended its ads on Facebook.
Will Facebook safeguard your right to privacy?
Does Facebook Have a Fiduciary Duty to Protect its Consumers?
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My concern about Facebook is the risk that consumers may lose their right to privacy. Facebook reminds me of a commission based Broker who sells investments with the Broker’s fee embedded in the product so that it gives the consumer the appearance of a “free product”. Nothing in the business world is really free. When you buy an advertised good you are paying for the advertising costs of the business. If you avoided goods that spend a lot on advertising those goods would probably have a lower price since lack of advertising means less demand and lower costs. People might be better off paying a fee for a customer owned non-profit version of Social Media so that the customers would have control over privacy. The customers could elect a board of directors that would require all employees to sign a fiduciary oath saying they work for the customer and will strive to find ways to detect privacy breaches and to defend the customer’s privacy. Currently Facebook works for the advertisers and has a duty to the advertisers to spy on the consumers as much as possible.
An analogy to this in the investment profession is that Brokers make customers sign a binding arbitration contract. The contract, until recently used an arbitration board that was packed with pro-Broker arbitrators who handed out small amounts of damages. The small size meant that expensive attorneys could not get involved so the hapless consumer didn’t get to assert himself properly. Brokers are not the agent of the customer and thus have no fiduciary responsibility. By contrast, a fee-only investment advisor is the agent of the client (we don’t call our clients “customers”). A fee-only investment advisor would be like a Social media site where all revenues came from clients’ fees and none came from other parties such as mutual funds or Brokers, etc.
I wrote an article “Installing a modem is like investing”. For information on fiduciaries see this page on my web site.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, May 24, 2012 @ 03:09 PM
Is Supply Side Economics Correct or Wrong?
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Supply side economics (the Laffer Curve) claims that cutting taxes can increase revenue because it rewards people for working. However most academic economists claim the theory is wrong. My opinion is that the theory, in certain conditions, is correct.
The problem with examining historical tax rates and assuming that taxpayers’ behavior is not affected by high tax rates is that in the past there were so many loopholes that past tax rates are not comparable in a linear way with current tax rates.
During the era from the 1930’s until 1974 the tax law was very loose about loopholes. A wealthy business owner could organize a tax deductible employer paid Defined Benefit retirement program with gigantic tax deductions for the owner and only tiny contributions for employees. In one case a person who earned $700,000 was able to get a $600,000 deduction for a pension contribution expense. Then in 1974 Congress restricted that.
In 1986 the TEFRA tax act closed more loopholes. Before 1986 you could buy a tax shelter with 3 to 1 leverage at the end of the year so as to negate the earned income from a W-2 job or self employment. Also there was special tax treatment for annuities, rental real estate, etc. that is no longer allowed. So the allegation that high income people’s behavior was unaffected by high taxes before 1986 is untrue because of the blatant loopholes.
During the 1990’s tax attorney’s and CPA firms began offering extremely aggressive complicated tax shelters that were legitimatized by including an opinion letter from a tax attorney in the file. Then in 2001 President Bush instituted an aggressive program to stop that by requiring tax advisors to issue a Circular 230 notice to clients. No longer could an attorney’s letter be used to help people construct a tax shelter with a flimsy letter of an attorney’s opinions. Thus another loophole was closed. The amount of income that was forced to be classified as taxable instead of sheltered has steadily increased despite nominal tax rate cuts.
The amount of taxable income in the old days when aggressive shelters were used
In addition AMT tax which started in 1969 has never been fairly adjusted for inflation. It was intended to catch people who made more than $400,000 in today’s dollars but now catches some who make only roughly $50,000. The annual $3,000 limit for capital losses has not been adjusted for inflation. The IRA annual contribution limit of $2,000 was not adjusted for inflation from 1972 to 2001 during which time it should have been raised to $12,000 to adjust for inflation. (It is now about $6,000). So simply looking at tax rates and assuming that rich people will report to work during an era of draconian confiscatory rates is not correct.
The type of people who make $500,000 earned income are the leadership class. Tax them excessively and they may drop out of the labor force, take early retirement, or move to offshore. What will happen if huge tax increases are imposed on high income people is that talented high achievers who enjoy working and who have funded their retirement programs will take early retirement. Younger highly paid workers could emigrate to other countries to obtain low tax rates. (Even though U.S. citizens are required to pay taxes worldwide, income from a “C” corporation overseas is not taxable until a dividend or wage is paid out, so having a corporation for a self-employed American overseas could result in tax savings). This will result in a brain drain as the most experienced, talented people leave the work force. The reduction of after-tax income will mean less will be spent by affluent consumers which will make the recession worse and thus reduce tax revenue and also increase the cost of welfare programs.
The result of tax increases will be more stagnation, decay and a lower standard of living as well as a worse fiscal position for the government.
I wrote an article “Taxes need adjusting for inflation”. See a posting “Financial planning ideas for year-end tax planning”.
Investors should seek independent financial advice. 
Posted by Don Martin on Wed, May 23, 2012 @ 01:45 PM
How to Protect Your 401k From Greek Default
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There is the possibility that Greece may withdraw from the Euro very soon, leading to global crash like the 2008 bankruptcy of Lehman Brothers. Investors ask how can they protect 401k from Greek default?
A Greek default could result in systemic European bank failures. European banks are highly leveraged with a 25 to 1 ratio of net worth to assets, which is far more leverage than a hedge fund and twice the leverage of an American bank. The risk is that bonds issued by European banks will default and become worth a tiny fraction of their face value. When buying bond mutual funds try to use funds that have minimal exposure to Europe. One problem is that multinational corporations that are nominally headquartered in the U.S. may have a European subsidiary which borrows money and it could end up being classified as a bond issued by a U.S. company.
Don't let your 401k become worth as little as a coin
The next problem that may result from a Greek default is that American banks may have lent money to European banks and those European loans will default, so even buying only American banks and bonds is risky. This explains why U.S. Treasuries are at record low interest rates this week as the marketplace anticipates something bad will soon happen in Europe.
The best way to protect 401k from Greek default would be to own U.S. Treasuries or domestic investment grade bonds.
The DXY dollar index (which shows the value of the dollar against currencies of other major countries) is at 82, which is the highest since October, 2010.
I wrote an article “Greek financial crisis may be Europe’s Lehman”
Investors should seek independent financial advice.
Posted by Don Martin on Tue, May 22, 2012 @ 03:50 PM
Has Facebook stock damaged your 401k?
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Facebook went public May 18 with an IPO of 38 which briefly hit 45 and closed today at 31.12, with a low of 30.95. The 18% drop from the IPO price is unusual for a profitable company’s new IPO. In three months a lockup will expire allowing 280 million shares to be sold; the IPO was 420 million so that will be a 67% increase in shares which could make the price go down.
The Wall Street Journal had an article criticizing the viability of Facebook which I fully agree with. Yahoo Finance had an article that Facebook’s investment bankers secretly cut Facebook’s revenue estimate.
The bottom line for Facebook is that it is simply like a newspaper or a broadcast TV station that offers free or low cost services to attract viewers and then uses those “sticky eyeballs” to sell advertising placement. If the free entertainment is not adequate then it will be difficult to sell ads. If the viewers tune out the ads it will be even harder to persuade businesses to pay for ads on Facebook.
Facebook’s claim to fame is that it allegedly has a high degree of knowledge about its viewers that allows precision targeted ads. But as time goes on people may be more evasive about what they do on Facebook or they may lose interest in Facebook rendering the database ineffective.
My opinion is that the new “Social Media” marketing is ineffective and is not worth paying significant amounts to promote a business on it. So eventually businesses will find this out and Facebook will not be able to make its ad revenue grow. When Facebook gets stuck with no sustainable revenue growth then the market will cut the PE ratio down to normal levels which would imply a value roughly a fifth of its $38 IPO price or roughly $7. It happened to tech stocks during the 2000 bubble and it will happen again.
Don't let your tech stocks drop to as little as the value of a coin
The impact of Facebook’s stock going that low is that the Social Media boom in Silicon Valley and advertising boom in Silicon Alley will fade away and this will undermine one of the biggest props in the stock market. Since the SP500 stock market has a 10 year PE that implies it is 50% overvalued then when tech stocks plummet this will pull down the SP500 stock market.
I wrote an article “Three things you must know about Facebook IPO” and “Facebook valuation problems effect on your 401k”. I warned people not buy Facebook and not use a 401k to own Facebook.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, May 21, 2012 @ 03:00 PM
Can the loss of jobs be offset by increased spending by affluent people?
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The key problem in the economy is a stubbornly high jobless rate. This means consumers can’t afford to consume as much in total as they did during the era of full employment, which means that the economy can’t grow fast enough for people to pay off their debts.
One possible hope is that affluent consumers that benefit from the new hi tech economy could spend more of their income to make up for the absence of consumption by the unemployed. However many affluent new economy professionals did not get a raise that was directly proportional to the lost wages that the unemployed people have lost.
If someone used to be a construction worker and is now unemployed the savings from not paying his wages is not transferred to a lucky tech worker. Instead the tech worker may have gotten a raise that merely compensated for inflation and was not a direct offset to wages lost by an unemployed participant in the defunct housing bubble.
The funds need to offset lost wages are not available
So the problem is that former participants in the housing bubble were making a living producing unneeded things and there is no offsetting gain associated with their loss of employment.
These unfortunate people will simply need to get retrained into a new career which can take several years before they complete the transition. During the time it will take millions of unemployed to make a transition society will have less purchasing power causing the economy’s growth rate to be low, which will mean a long term recession. This justifies today’s low interest rates and high bond prices, although investors must remain vigilant against the risk of inflation damaging their bonds.
I wrote an article “Worsening unemployment and tax increases to create new recession”.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, May 18, 2012 @ 04:20 PM
Ultra-low interest rates are creating more problems than they solve
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The very low interest rates are forcing banks and insurance companies to gamble with their investments to make up for the lower returns they get from traditional investments. These companies are allowed to use hypothetical loss estimates which can be changed. They are allowed to “mark to book value” (the purchase price) or they can recognize a gain when they sell. So these companies are skating on thin ice by taking increasing greater risks to earn money through short term trading like the fiasco at Chase where Chase lost $2Billion to $3Billion in bonds CDS contracts.
The risk to society is that one day a bank may be forced to admit that it legally hid its losses by using “mark to model” accounting and lowballing the estimate of future losses for its loan portfolio. A bank could get around the Volcker rule by loaning money in a profit sharing agreement to a tiny speculative hedge fund and essentially the hedge fund would pretend to take all the risk and the bank would pretend it was just a loan which had a profit sharing contract with the borrower. However, if the hedge fund lost money and thus the loan became worth very little the bank could pretend the loan to the hedge fund was still worth face value. Eventually the truth will come out that the Fed’s easing has merely warped and camouflaged financial problems and made them worse.
Examine the hidden bank secrets
An interesting quirk with Chase’s loss is that this may make their bonds go down in value, so the bonds can be bought back by the bank at discount, thus creating a profit. So bad news is good news. Maybe the employees who lost money should be given a bonus for enabling the bank to profit from a drop in the value of its bonds.
Unfortunately for Chase their London subsidiary that lost $2Billion in derivatives may not be able to make the tax deduction for the loss flow through to the parent corporation as offshore subsidiaries don’t pass through either losses or gains until they mail out a dividend check.
I wrote an article “Two things you must know about huge Chase loss”
Investors should seek independent financial advice.
Posted by Don Martin on Thu, May 17, 2012 @ 02:58 PM
Investing in Hard Currencies of Developed Countries
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Investors wonder if they should invest their 401K in foreign currency to protect from devaluation of the dollar. People want to know if they should own Developed country “Hard Currencies” instead of Emerging Markets currencies.
There are three currency strategies to protect from dollar devaluation:
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Gold bullion is considered a form of money or currency by some investors. I disagree. I think it is no more a currency than owning a coal mine or an oil well. Can you buy groceries, gasoline, and airplane ticket with a Krugerrand? During deflation or financial crisis these hard assets can go down in value.
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Emerging Markets currency. The Balassa-Samuelson effect shows that rapidly growing EM countries outpace the Developed countries growth rate leading to an increase in the value of EM currencies. I think the EM currencies may go up in the long run but may experience so much volatility that they feel like a stock instead of money. They will go up at the same time that the stock markets in EM countries go up o with so much risk and volatility then why not just by EM stocks as a hedge against a devaluation of the dollar or as a way to make money from EM currency appreciation? Many times the reason for EM stocks to go up against domestic stocks has been due to currency appreciation.
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Developed countries with “Hard Currency”. Examples would be Australia, Norway, Sweden, Switzerland, Singapore, Canada, and South Korea. The problem is that these countries may appear to have “Hard Money” policies but those policies can change with the next election. If exports drop in those countries then voters will demand a devaluation. These countries are often rather small statistical outliers and there is no guarantee their leaders will continue their prudent fiscal policies. In the case of Australia and Norway they depend on commodity exports which are heavily warped by the Chinese debt fueled hyper active growth rate which is unsustainable. So when China stops buying commodities then commodity exporters may crash and this will hurt a lot of the attractive foreign currencies such as Norway, Australia, Canada. It will also hurt Singapore, South Korea. It is way too risky to own all of one’s money in the Swiss Franc as it has over-appreciated by a huge amount and the voters want the Franc exchange rate lowered to help their export industry.
There is talk now that the only solution to the Eurozone problems is for the European Central bank to engage in massive money printing which will create inflation. The shocking news is that Germany will probably break its 89 year tradition of avoiding inflation at all cost in order to allow the ECB to save the Eurozone with a dose of significant inflation. So if a prosperous, disciplined country can’t be relied upon to stick to Hard Currency principles then what can an investor trust?
The reason for investors to own foreign currency should be for diversification purposes. However diversification is increasingly becoming less relevant tool for investments because most assets tend to become more correlated during crashes just at the time when investors need uncorrelated assets.
Open the doors to new viewpoints
In terms of trying to forecast the future it may be that the global economy is headed into recession and that the U.S. will be the “least worst” haven with the best probability of recuperating from the past and future problems. Thus foreign currency may not be useful during the coming global recession, so investors may want to lighten up their positions. The DXY index, which shows the value of the dollar against major developed country currencies, is reached new highs and the 10 year Treasury yield has retouched its 12 month low of 1.70% in the past hour, implying that foreign assets are fleeing into the safety of Treasuries and new bull market in the value of the dollar may be starting.
I wrote an article “Foreign currency investing” and “Emerging market currency – is it OK?”
Investors should seek independent financial advice.
Posted by Don Martin on Wed, May 16, 2012 @ 05:21 PM
How to buy Facebook Shares in a 401k
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Facebook is doing an IPO on Friday, May 18, 2012. People want to know: can I use my 401k to buy Facebook IPO shares? They want to know if Facebook IPO stock is available in a 401k.
To be able to buy Facebook shares in a 401k the Custodian who runs your 401k must allow that. I have never heard of a Custodian who does that. Typically the Custodian offers only mutual funds and maybe the employer’s stock. However about 22% of 401k’s allow a “brokerage window” that allows purchase of any publicly traded securities. To use that, assuming you have a broker window, one would need to contact the brokerage and ask them to sell you some IPO shares of Facebook. If only a few brokerages have Facebook shares available during the IPO then it is possible, even with a 401k brokerage window, that you would not be able to buy the Facebook IPO in a 401k.
If someone is self-employed and has a 401k then their Custodian should allow the freedom to invest in any publicly traded securities inside their 401k. A self-employed person could order his 401k to be closed down and rolled into an IRA, but I would not recommend that just to buy a stock.
Alternatives to Buying Facebook Shares in a 401k
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Some creative approaches would be to get a loan of up to $50,000 from your 401k and send the funds to a broker that offers a chance to get Facebook IPO shares. The risk is the broker might not be able to get the shares for you. A serious risk is that Facebook is a dangerous speculative type of investment that is too risky for a retirement account, so please don’t buy Facebook with retirement funds. Further, retirement accounts don’t get Long Term Capital Gains tax treatment, so Facebook IPO stock (assuming you think it will go up) should be held in a taxable account to get the best tax treatment.
Another way to use 401k money to buy Facebook is to request an “in-service” distribution of your 401k funds to an IRA. This means that you can transfer your 401k to an IRA while still working at the employer. This can be done at any age, as long as the employer allows it. Mitt Romney’s former employer allowed employees to “retire” at age 23 and roll assets from a 401k to an IRA with an “in-service” withdrawal. There is no tax on this. Most employers don’t allow it.
An IRA account has lots of freedom so your chances of getting a broker to allocate shares of Facebook IPO shares in an IRA are just as good as outside of a retirement account. My opinion is that Facebook stock is not recommended for purchase, especially if your intent was to use it for retirement. The only thing “retiring” might be that your dollars will “retire” meaning you won’t have them working for you if they are lost in a bad investment.
Perhaps some people can indirectly own Facebook shares by owning mutual funds that will buy Facebook. Some tech stock index funds will need to buy shares in Facebook to meet their mandate to own the tech stock sector. However, I’m concerned that index funds are not good because I believe in mutual funds that use “active management” instead of passive index funds and who will try to pick stocks carefully, so I would not try to own mutual funds that are likely to own Facebook.
I wrote an article “Two things you must know about Facebook IPO” and “Sell in May and go away”, and “Are your funds trapped in a 401k?”
Investors should seek independent financial advice.
Posted by Don Martin on Wed, May 16, 2012 @ 01:31 PM
Barron’s ran an article today by Randal Forsyth “The Bear Is Back, Say Chartists”. He said “There's a saying among traders that the hardest trade is the right trade. Going to cash that yields zero is the hardest trade and made more so by central banks that are keeping a lid on interest rates.” Wow! What a great quote, he thinks just as I do. I have been saying this for a long time that it is better to accept zero return (net of inflation) from bonds than to lose money in stocks. If you own a stock valued at $100 a share and it drops 50% and then goes up 50% then the stock will be worth $75 and your $25 a share loss may not be fully tax deductible if it exceeds the $3,000 annual limit. The Barron’s article also quoted Richard Russell, the dean of chartists, as saying that a hard crash for equities including gold stocks is coming despite efforts by the Fed and Congress to stop it. He advises people to get out of all common stocks now, which I agree with.
Could this be all that a fully margined stock investor will have left after a hard crash?
I wrote an article “Sell in May and go away” and “Stock market looking weaker”.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, May 15, 2012 @ 04:17 PM
Bank Stocks' Inflated Values Warp the Stock Market
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Barron’s ran an article today by Randall Forsyth "What JPMorgan isn’t saying – the returns are lousy” where he wrote that banks can never regain their previous peak earnings because they are no longer allowed to do some risky things. The Volcker rule limits aggressive high profit activities by banks so they can’t expect to regain their historical peak earnings. It reminds me of my blog article yesterday “Two Things You Must Know About Huge Chase Loss”.
The banking industry has made its profits by taking excessive risk in speculative transactions that are not appropriate for a bank. Banks are levered up roughly 12 to 1, which is more leverage than a hedge fund. For example, see the banking index ETF ticker KBE. Before the 2007-2009 crash it was around $50 a share and after going down to $11 in February, 2009 it is now at $22.
Don't let your bank stocks become worth as little as this coin
However, investors have not fully priced in the risk of a permanently lower level of bank earnings. Further banks are a special industry where Congress intervened and passed a law allowing them to ignore mark to market and instead keep bad loans on the books at the original face value. Since accurate loan loss estimates are crucial to determining a bank’s earnings then the law has made it possible for banks to legally camouflage their true earnings condition. This extra layer of uncertainty increases the risk of a sudden burst of panic sell orders since it is harder to get reliable data on a bank than on a manufacturing company. Further the dividends paid by banks have lured hedge funds into buying shares so that they can profit by borrowing at 1% and getting a 2.5% dividend then lever up the spread margin profit to make a large profit. Once bad news comes out then the over- leverage hedge funds will need to sell their bank shares. Since the KBE index ETF was down to $11 during the 2009 crash 50% below today’s value then it could retouch the lows if another stock market crash occurred. And since the coming 2013 tax increase will hurt an already fragile economy I’m expecting an economic crash and a stock crash at the end of the year. This will hurt the quality of bank loans making banks stocks go way down.
I wrote an article “80% of loans were not safe”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, May 14, 2012 @ 05:13 PM
China’s economy is cooling and when it settles down and cools off then there will be a huge drop in the demand for commodities causing the price to drop massively. Since inflation-phobic investors have overpaid for inflation sensitive investments such as commodities and real estate then when these investors are hurt by the very investments that were supposed to protect them then there will be a massive panic sale of those investments when investors realize they were overpriced.
Michael Pettis has an excellent article about the Chinese economy cooling down and the subsequent crash in global commodity prices. A striking article about the world going into deflationary slump because of China’s economic cool down was written by Ambrose Evens-Pritchard.
The main driver of global growth has been China and its global demand for commodities. Once that demand has faded away then there won’t be any major forces driving demand. And once the Eurozone loses its credibility in the fight to save the Eurozone then that will produce a global slump.
"Our feeling is that this commodity super-cycle has ended, and ended really in 2008," said Michael Shaoul, of Marketfield who was quoted by the Wall Street Journal.
The huge tax U.S. increases of 2013, starting in 7.5 months, as well as proposed state government tax increases will create a fiscal drag of 5% reduction of growth from positive 2% to negative 3% and this will also hurt demand.
Massive tax increase coming in 2013 as big as this pile of money
The inflation statistics released on Friday, May 11 show the core crude PPI was negative 1.8% last month and negative 4% in the past 12 months.
The best way to prepare for deflation is to look at the past 22 years of Japanese deflation and see that in Japan that only their Treasury bonds did well; all other investments were a false hope. A similar fate may await the other parts of the developed world, limiting investors to a choice of various investment grade bonds, cash, etc. as they wait for the storm to pass.
I wrote an article “Will China slowdown hurt commodities?”
Investors should seek independent financial advice.
Posted by Don Martin on Fri, May 11, 2012 @ 02:58 PM
Huge Loss at JPMorgan Chase Shows Bank Stocks are Too Risky To Own
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Chase incurred a $2 billion loss last night because of a risky bet on derivatives. The firm bet that corporate bonds would not go down in value because of credit quality risk so it sold CDS protection on bonds, which is insurance against credit risk. But when the economy heads into recession then credit quality deteriorates and corporate bonds go down in value due to fear of the increasing risk of default. (Although a recession also makes investment grade bonds go up in value so sometimes the two conflicting forces cancel each other out). The bank owns loans which go down in value when a recession occurs, so the bank, by selling derivatives that insure against a failure in corporate bonds, was actually doubling up its highly leveraged bet on the economy. Banks are levered up about 16 to 1, which is far higher than other industries, and far higher than hedge funds. To take on even more risk in the same direction when one is already highly leveraged is wrong. This loss is one-eighth of a year’s profit. It’s 1% of the company’s net worth. Bloomberg News said it is one of the biggest trading losses in history. Read this Marketplace.org report for a detailed report.
To be fair to Chase they were the only giant bank that did not ask for a TARP bailout and they did a good job of risk management before the crash of 2008. They were the only bank that had enough wisdom to refuse “Easy Qualifier” loans to people who worked in the dangerous mortgage and real estate industry during the mortgage bubble era.
Beware of huge banks with huge piles of money
Since Chase only lost 1% of their net worth (even less after taxes) this is merely a bump in the road for them and is not a reason to panic or to refuse to do business with them. The purpose of this article is to warn investors that in general bank stocks and other financial stocks are too much of a risky leveraged bet on the economy so one should consider avoiding bank stocks regardless of where we are in the economic cycle. The biggest problem investment advisors have with bank stocks is that they are too opaque to know if their loan loss provisions are accurate. A bank could low ball its loan loss provisions which would make the company look profitable only to find in later years that the losses were greater. There is case where a famous manufacturing company got half its profits from its finance unit and used loan loss provisions to manipulate the earnings statement thus creating a fairy tale of stable income. This statistic is impossible for outsiders to accurately estimate so outsiders are forced to gamble when they buy bank stocks. This gamble is further compounded by the highly leveraged nature of banks. Yes, I know Warren Buffett owns some bank stocks so not all banks are too risky, but in general, publicly traded bank stocks are higher risk than other publicly traded stocks, so you may not get a fair return on capital in proportion to the risk you take.
The new Volcker rule means less profit for banks in the future (because they will not be allowed to do proprietary trading for their own account), so old high water marks of profitability will not be reached. Banks are over leveraged. Bank stocks are too risky. Chase’s stock price three year standard deviation is 33 versus 15.6 for the SP. Lending is a disguised form of contingent ownership because during a recession failed borrowers let their loan default and then the banks end up owning the asset they lent to at precisely the time when that asset is a failed investment.
I wrote an article “80% of loans were not safe” which is about mortgages in general and not about Chase.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, May 10, 2012 @ 06:36 PM
Very weak economy hints at 2012 stock crash
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The first quarter GDP was so weak that 1.6% of its 2.2% growth was due to automobile purchases. (This is 73% of growth). And if the inventory rebuild was removed then the GDP growth was 1.6%. So removing both of these would imply that excluding both inventory rebuild and automobile sales the economy grew by 0.43%, which is far below stall speed.
My favorite economic indicator is unemployment, especially the employment to population ratio which went down 0.1% last month (a downward move means there are fewer people working).
The economy will feel as worthless as this coin during the crash
The “stall speed’ for the economy to keep from stalling and falling like an airplane is about 2% growth. If growth excluding automobiles and inventory rebuild was 0.43% annualized and the job market got worse last month then that is bearish news which justifies the recent significant drop in long term Treasury yields., which are now near a 12 month low.
If stocks crash then fund managers and MBS packagers will move some assets to Treasuries causing demand to rise for Treasuries (so yields will fall). The massive 5% fiscal drag starting with 2013’s tax increases is only 7.5 months away.
I trust the wisdom of the bond market’s collective judgment but not the stock market’s judgment. Stock prices are often driven by the actions of naïve, emotional retail investors; by contrast the bond market is considered so boring that it drives away those type of investors leaving the decision making to seasoned, wise professional investors.
I wrote an article “Recession to come in 2012 not 2013” and “Sell in May and go away”.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, May 09, 2012 @ 04:03 PM
Tax planning with employer issued stock options
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When a tech company employee gets a stock option from their employer in some cases the unrealized profit maybe 90% of the employee’s wealth. This may cause the option owner to get too emotional and refuse to exercise the option and invest the proceeds in a diversified portfolio.
One of the key tenets of financial planning is to get insurance against unaffordable risk. You insure your house, your car, you buy life insurance if you have dependents, but did you remember to insure your assets against a crash? To buy insurance against a stock crash one might have to pay an exorbitant sum to buy put options with a strike price equal to today’s stock price. So the alternative would be to diversify by liquidating the employee stock option and investing the proceeds in a diversified portfolio.
A huge amount is at stock with employee options on Tech stocks
Some Silicon Valley tech workers have accumulated large capital losses from the great Bubble Crash of 2000. They want to know if they exercise their ISO options to buy the employer’s stock and then sell the stock will that generate a capital gain that can make use of the loss suspension of old capital losses from previous sales. The answer is that in order to get Capital Gains treatment of stock acquired by the exercise of an ISO option one must hold the stock for a year after exercising the option and must also hold the stock at least two years after the option was granted. Any sale of stock sooner than that is a “disqualifying disposition” which results in “ordinary income”, which can’t be netted against accumulated suspended capital losses, except for the annual limit of $3,000 a year.
When a financial planner is confronted with the dual problem of tax planning versus investment planning the need to make the correct investment decision usually overrides the need for tax planning. Thus if an employee stock option owner needs to decide to acquire stock by exercising an option the best answer is to see if the stock is too risky to hold rather than to attempt to maximize tax benefits. If your tech stock drops 90% as some did in the 2000 crash then you would have been better off doing a cashless options exercise without holding the shares and taking the cash and diversifying it into boring, dull, unglamorous companies that make wimpy returns of 5% but which don’t have dotcom crashes of 90%.
The history of tech stock IPO’s is that usually in the first few months the stock does well and then in the case of tech companies the stock eventually goes down below the IPO price. Thus tech employees with company stock options should remember that the opportunity to make a profit from options may be a once a decade lucky break and that they may not be in the industry a decade from now, so this is your nest egg, don’t gamble with it. Reduce risk, diversify, invest with caution. Tech workers say the stock options are “house money” meaning free gambling chips paid for by the casino, but I disagree. They are simply another form of compensation and should not be wasted as one never knows if they will be around in a winning company in the tech industry in the next bubble to collect another windfall. Never view your hard earned compensation as a gift of free gambling chips!
I wrote an article “Hidden risks of employee stock compensation”.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, May 08, 2012 @ 07:56 PM
Senator Lugar’s Loss Hints at Higher Taxes and Deflation
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In conservative Indiana the incumbent Senator Richard Lugar was defeated in the primary today by a Tea Party Republican, state Treasurer Richard Mourdock. This gives the Democrats a chance to get this Senate seat which would increase the chances of no repeal of the tax increase scheduled in 2013. A tax increase during a time of high unemployment is a classic way to create deflationary economy. In less than eight months new Federal taxes will create 5% drag on the economy during a time when the population adjusted “real” rate of job creation is zero and the GDP growth rate on a warm weather adjusted basis is probably 1%, which is below the 2% “stall” speed. This means the economy will stall out into a recession. Since stock markets often anticipate events ahead of time then the crash may come months before January.
Of course if the Tea Party candidate wins the November election then there will be more budget deadlocks in Congress with the threat of Treasury default, which can hurt financial markets. And if the Tea Party actually did take full control of Congress they would have a massive austerity program that would not help to create jobs, although in the long run cutting government expenses, assuming taxes were also cut in tandem, could help the economy.
I wrote an article “Romney victory won’t fix stock market.”
Investors should seek independent financial advice.
Posted by Don Martin on Tue, May 08, 2012 @ 01:13 PM
Can I use my 401k to invest in Facebook IPO?
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Investors are hoping they can get rich buying the IPO of Facebook. They want to know if they can buy it in their 401k.
Most 401k’s don’t have a brokerage window which allows someone to purchase any publicly traded stock or bond. Instead most 401k’s limit the choices to a few mutual funds or possibly a wide variety of open end mutual funds. Some mutual funds could chose to buy shares of Facebook, so perhaps some of the mutual funds in a 401k will end up owning some Facebook shares.
People worry a government debt crisis will hurt their 401k or a crash in the Eurozone will hurt their 401k, however the biggest risk is that an investor would shoot himself in the foot by buying dangerous bubbly overpriced tech stocks. So I would not recommend buying Facebook in a 401k. And if Facebook stock did dramatically appreciate it would be better to own it in a direct manner outside of a retirement account because when funds are withdrawn from a retirement account they are taxed as ordinary income. By contrast capital assets held over a year outside of a retirement account are subject to lower Long Term Capital Gains rates (some exceptions apply for collectables and commodity futures) and all taxes on unrealized capital gains are waived at death. Also some investors have a huge hangover of accumulated unused deductions for stock losses in the last tech crash of 2000, so to net out gains against losses they should buy investments (which they believe will go up in value) in a taxable account instead of in a retirement account. For tax planning, the best things to put in a 401k or IRA are bonds because they produce ordinary income and they need to be sheltered from tax so as compound over many years. Also a 401k should hold lower risk assets to protect your retirement assets from a crash.
Don't pay excessive taxes on 401k stocks because of poor tax planning
My forecast for Facebook’s share price is that there is too much risk they won’t reach the level of growth and profitability needed to justify their IPO stock price and their shares could be like Cisco’s stock which was about $80 in 2000 during the Tech bubble and has now in recent four years traded at a maximum of $26.93. After adjusting for inflation Cisco’s 2000 high was roughly $96 (in today’s dollars), now it is at $18.67, a decline of 80%. The bottom line is that if Facebook can’t impress corporate executives to purchase massive amounts of ads then Facebook will have a mediocre future that will not justify its IPO price. Have you ever bought anything advertised on Facebook? If the sales and profits don’t improve in 12 months then the stock price will go way down.
I wrote an article “Six things you must know about 401k risks” and “Planning for Treasury debt default hurting 401k’s”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, May 07, 2012 @ 04:04 PM
David Rosenberg said unemployment would be 11% if not for drop in the labor force participation rate; for men its worst ever since survey started in 1948. He also said April’s unemployment rate would be 8.4% instead of 8.1% if the labor force dropouts were counted. My opinion is that I have been using the employment to population ratio (not the same as the labor force participation ratio) as the key factor in judging the economy and on May 4th it got worse by 0.1%.
Currently 114.5 million are employed, but to adjust for population growth of 120,000 monthly in the past 10 years, using 2002 as a benchmark, when there were 112 million people employed we need 126 million jobs today so we are about 10% short of number of jobs needed. 144,000 is the average payroll monthly increase since 2009 trough; the amount needed for population increase is 120,000 so the net amount of jobs created above the population increase is 24,000 monthly. At this rate the unemployment rate will be reduced by 0.25% a year, which would require roughly 16 years from today to reduce it from 8.1% to 4%. The Economist magazine says 2013 fiscal cliff is 5% drag on the economy; previously other sources had suggested only 3.5%, so that’s a shock, so if economy is at 2% (this is the stall speed) then 2013 there is a high risk of a crash.
What will happen in less than eight months? A huge tax increase and reduction of stimulus spending. This will push the economy will be going into recession making stocks will crash. The tax increase will be to go from 35% to 43% for interest which may affect bonds; by contrast the tax increase for dividends will increase from 15% to 46%, thus causing a higher degree of motivation for owners of stocks to sell. Most people try to hold stocks in a taxable account and bonds in a tax-deferred account so the owners of dividend paying stocks will be much more motivated to dump their assets due to the tax increase than will people who own bonds and CD’s.
A flood of Eurozone paper money will hurt the Euro
Euro members especially Germany willing to suffer inflation to avoid being seen as the evil country who destroyed the Euro, so they will make the Euro survive even if they have to do so with massive money printing and inflation. This implies the Euro would go down against the dollar and that investors would flee into the comparatively safer U.S. Treasury market to avoid being hurt by Eurozone inflation. Currently the ECB is printing massive amounts of Euros in the form of lending to banks so that banks can buy government bonds. That is inflationary, which means the Euro will depreciate against other currencies.
I wrote an article “Employment report to damage 401k’s” and “payroll report to hurt stocks”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, May 07, 2012 @ 12:45 AM
On Sunday elections in France and Greece threw out incumbents who had advocated fiscally responsible austerity policies and installed new governments that will take actions that will reduce the probability of survival of the Euro currency. The risk is that other Eurozone countries could decide to follow the lead of France and reject previously agreed to austerity programs thus leading to a weakening of the Euro. This will lead to the Euro currency's collapse over the next few years.
This will make it harder for U.S. companies to sell their products to Europe and will make European stocks go down and will make global stock markets go down. Investors will flee into the safety of U.S. Treasuries, making U.S. Treasury interest rates go even lower. On Sunday night some global stock indexes dropped 2%.
Investors should protect their 401k by holding mutual funds that own investment grade bonds issued by companies that have minimal need for sales in Europe, with particular attention to avoiding the bonds of European companies, especially European banks.
I wrote an article "French election effect on your 401k".
Posted by Don Martin on Fri, May 04, 2012 @ 11:21 AM
Today’s non-farm payroll report shows economy getting worse
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The non-farm payroll report issued this morning shows a jobs increase of 115,000. This reduced the official unemployment rate from 8.2% to 8.1%. I had predicted 120,000. The consensus of economists had predicted 162,000. Since the amount needed to offset the population increase is 120,000 monthly new jobs then basically no progress was made in reducing unemployment.
The number of people working fell 342,000. This means 462,000 people dropped out of the work force, possibly to collect disability. The new applications for disability have been rising sharply since the start of the recession in 2007. If one adjusts for the discouraged unemployed then things got a lot worse in April. If one adjusts for the rare third standard deviation very warm winter weather then the winter payroll increases were a fluke and should be adjusted downward.
Open the secrets of the payroll report
The ultimate expert on the amount of hidden jobless people is the bond market. Today bond yields went down to 1.88% for the ten year Treasury. The last time it was this low was February 2nd, it had been 2.38% on March 19th. A drop in interest rates correlates with an increase in unemployment, so the bond market is telling us that unemployment and recession conditions are getting worse, which will damage your 401k.
The 2013 tax increase will start in less than eight months which will push the economy will be going into recession making stocks will crash, which will damage your 401k.
The employment to population index fell (meaning unemployment is getting worse) by 0.1% after being stuck at 58.5% for along time. It has not been this worse since the bad 1982 recession. This should be used to judge the economy rather than the non-farm payroll report which claimed a 0.1% improvement in employment.
I wrote an article “Payroll report to hurt stocks”.
See article in FT.com by Pimco's president "Confirmed America's Jobs Crisis"
Investors should seek independent financial advice.
Posted by Don Martin on Fri, May 04, 2012 @ 11:00 AM
Tech bubble ripe for bursting
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Facebook’s IPO will occur May 18. The IPO price maybe significantly less than what some investors paid for shares last year in a private placement. The company is now large enough that making decisions for paying for Facebook ads on it by major companies is something that is now too big of an event to be handled solely by the marketing department of a company, now the CFO of a company needs to get involved and ask hard questions such as “does this ad campaign really produce results?” Ultimately Facebook is just another advertisement revenue generating media company just like newspapers and broadcast television were before the internet era. (Of course Facebook claims to be better than other media companies because of the ability to custom tailor ads with high quality data on prospective buyers). If a media outlet can’t sell plenty of ads at lucrative rates then the media company will fail and go out of business.
An article in the Wall Street Journal on May 1 “The Big Doubt Over Facebook” had an excellent quote from Martin Sorrel, president of WPP, the world’s largest ad company. He said that in the past ad clients impulsively purchased Facebook ads “because it’s fashionable to do so” and now the clients’ finance departments are starting to examine this. Presumably large corporations will become more unwilling to spend vast sums on Facebook ads once they can document they are not getting adequate results. My opinion is that for Facebook to grow enough to justify its valuation it must persuade the Fortune 500 companies to place a huge amount of ads and these companies may find that the ads don’t pay.
So if the Facebook ad fantasy bubble bursts then the Social Media business will fade away and the Silicon Valley boom will cool down, making tech stocks go down.
Unlock the future of Facebook's revenue
There have been more articles recently showing how Apple can’t keep up its growth rate forever as eventually the market will be saturated. Also at some point competitors will make a heroic effort to band to together to fight a monopolist and offer really great deals to stop a monopolist.
Many articles have been written that a handful of tech companies are propping up the market averages. If these few glamorous tech companies became weak and went down in value that would be enough to start a market rout. Couple that with the coming Federal government fiscal cliff in 2013 when a 3.5% drag on the economy from tax increases will tip the economy into recession and you have another reason for a stock crash.
I wrote an article “Facebook valuation problems effect on your 401k”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, May 03, 2012 @ 12:30 PM
Tomorrow’s non-farm payroll employment report will be about 120,000 new jobs which is roughly the amount needed to keep up with population growth. Thus there will be no improvement in the unemployment rate. The bond market has already priced this in but the stock market has not. The effect on the stock market will be a drop in stock prices.
The drop in stock prices could wake up stock market investors to the risk of a big stock crash that will occur by year end. When stock owners become aware that there will be a big fiscal cliff in 2013 when taxes go up and stimulus programs end (only seven months and 28 days from now) they will want to sell. When they realize that the market anticipates bad news several months in advance then soon it will be time for another summer time sell off of the stock market just like the last two years.
Bloomberg had an article “Disabled Americans shrink size of labor force” where they mentioned a 22% rise in disabled claims in the past four years, far more than normal. So some unemployed people are “hiding” on disability rolls.
A huge amount of money is at stake if stocks crash
My favorite statistic is the employment to population ratio which has been stuck at 58.5% for several years at a level not reached since the bad recession of 1982. This is more important than the non-farm payroll report, which is not adjusted for population growth or for freak warm weather.
I wrote an article “Bond bulls validated by payroll report”.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, May 02, 2012 @ 04:52 PM
Don’t be fooled by private money lending
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Private mortgage lending or investing in “hard money” mortgage Notes or a Deed of Trust is something that is becoming more popular with investors. I used to work in the lending business and am strongly opposed to individual retail investors buying or funding a loan.
The baking industry is very competitive. They already have corneded the market in terms of acquiring the best borrowers, so the only ones left for small investors would be high risk borrowers that banks won’t accept. Banks are the professionals: they know what is a loan that is a reasonable risk, they know how to generate the proper legal documents that protect their rights during a foreclosure, they know how to handle defaulted debt in a way that is more professional and cost effective than single retail individual could do.
The problem with affluent individuals loaning money to needy, shaky poor quality borrowers is that there is a huge gap in attitude between the two parties. The investor is so affluent he can’t imagine how ruthless or desperate a borrower can be or will become so the investor is taking on hidden risk of default and foreclosure that he is not emotionally prepared to deal with.
The risks of private lending to poor quality borrowers include: risk of failure underestimated, risk of failure to diversify, risk of becoming an involuntary owner of a property through foreclosure (for example imagine owning through foreclosure a tainted property that requires a huge expenditure to remove toxic waste), risk of a lawsuit over alleged failure to properly disclose loan terms, risk of improperly executed paperwork either at the start or during foreclosure, risk of taking a lot of time off work to meet attorney and go to court over a loan that has a value roughly equal to the attorney’s fee, risk that “junk bond” quality loans could suffer an 80% loss in bankruptcy plus a loss of interest for several years (during bankruptcy no interest accrues).
To be a successful private investor in Notes it would be best to have a large diversified portfolio of them, have a full time loan expert on retainer who is legally obligated to be exclusively your agent and not the borrower’s agent.
The crucial missing item in loans not accepted by banks is not the lack of good credit but rather it is the lack of income as defined by the bank. So the private party lender gets stuck with lending to someone who has shaky income which is the worst type of lending mistake. Poor quality or inadequate income is what destroyed the Tech stock bubble of 2000, the real estate and mortgage bubble that crashed in 2007-08, and it is the factor that destroys “asset based” lending. It is what fools uninformed retail Note investors. It is hard to judge the “quality” of income unless someone is a fulltime loan underwriter. It is the lack of this critical skill that causes investors to be exploited by “B” paper borrowers.
The misunderstanding that retail Note investors have is that they assume that a mortgaged asset will never drop in value, never become old, worn down, unpopular, will require no marketing expertise to sell, will be perfectly maintained by a poor borrower with a reckless behavior pattern that resulted in poor credit. They assume the borrower will quickly and meekly cooperate to complete the foreclosure and that there will be delays in the court system, etc., etc. The reality is that private non-institutional lending only works if the borrower magically is fated to never default. If the borrower defaults then the structural nature of high foreclosure costs eat up the profits and cause losses.
So leave lending to the pros and if you want to invest in high risk high yield debt then settle for publicly traded junk bond, preferably by buying shares in a mutual fund that specializes in that. There mutual funds that invest in bank loans, junk bonds, Emerging Market debt, etc. where you don’t have to hire an attorney, a loan document drawing expert, a loan disclosure expert, a foreclosure expert. You simply click on a Broker’s website and buy the mutual fund after carefully shopping for the right funds. Of course, junk bonds are risky too. I would prefer that people avoid junk credit regardless of how it is made available to them.
I wrote an article “80% of loans were not safe”.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, May 01, 2012 @ 03:22 PM
Housing’s Century of Losing Money
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An article in MarketWatch.com titled “Why U.S. House Prices Won’t Recover” said “When will U.S. house prices recover? Likely never”. The article said there has been no inflation adjusted increase in house prices since 1895.
Pimco mutual fund’s website mentioned this several years ago, too. That’s right, for the past 117 years you would have made zero appreciation (net of inflation) if you bought a house with no leverage. Of course you would have gotten a bond like rate of return in the form of rent which is like a bond’s yield. (When I say bond-like, I mean that the yield from rent is roughly similar to the yield from a bond. However the risk on real estate is far higher). By contrast the “real” (after-inflation) rate of total return for stocks has been 7% and 3% for bonds. In addition, when you own publicly traded securities you have easy access to your funds, including ease of sale, ease of borrowing against them, etc.
The reason real estate did not increase faster than inflation is because the raw components except for land don’t go up any faster than inflation. But you may think because they are not making any more land that this would create land shortage and a faster than inflation increase in real estate prices. The reason this did not happen is because outside of the biggest cities there is lots of cheap farmland that can be used to build houses and the people who live there may not earn very much, so non-urban real estate suffers from a never ending surplus of land and a shortage of well qualified buyers. Also existing buildings can be torn down and replaced with multistory buildings and new land can be made on shallow waterfront areas.
However in urban areas with access to a sophisticated employment market like Manhattan or Palo Alto the price of land has gone up faster than inflation as consumer engage in a bidding war to buy a home close to lucrative centers of employment. The elite urban areas have pulled up the average U.S. home price. So if a Palo Alto house goes up faster than inflation then this means the average non-urban home actually went down when adjusting for inflation, if one subtracts out the effect of elitist neighborhoods on a national housing index.
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Once the economy returns to normal in five to seven years from now the Federal Reserve will declare war against inflation by raising interest rates to higher than usual levels. The resulting higher cost to borrow will reduce demand for housing thus causing houses to go down in value.
I wrote an article “Real estate crash will continue” and “Inflation hurts real estate”.
Investors should seek independent financial advice.