Posted by Don Martin on Fri, Jun 29, 2012 @ 05:07 PM
RIMM’s stock down 95% from peak- How Does This Affect the Tech Stock Economy?
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Research in Motion which makes Blackberry (ticker RIMM) has had a severe downturn in market share in just two years. See the Wall Street Journal article. Their stock price dropped 95% from its high of 2008, which is about the same percentage decline in value as a Lehman Brothers bond.
And Research in Motion is not the only tech company with stock market problems. Nokia went from $30 to $2 a share. Remember Palm company, which got bought out by HP? Then about two years later HP simply shut it down.
Is all that you will get from tech stock investing a little coin?
In the 25 years that I have been in Silicon Valley I have repeatedly seen this pattern where a company is very popular for a few years and then fades into obscurity. These glamorous tech companies fade away so quickly. It reminds me of Warren Buffett’s observation that in a century of aviation the publicly traded airlines never made a profit. Investors have made a mistake of getting excited about technology and overpaying for risky tech stocks. Typically only a tiny handful of tech companies have an outstanding performance in the stock market because the investors in most tech companies overpay for its stock starting with the IPO. In addition the hidden risks of a tech company are greater than for producers of a less glamorous product. The presence of excessive, uncompensated risk is what really hurts investors; the key to investment success is to avoid excessive loss rather than seek windfall profits.
I wrote an article “Will tech crash lead to stock market crash?” and "Facebook valuation problems effect on your 401k".
Investors should seek independent financial advice. 
Posted by Don Martin on Thu, Jun 28, 2012 @ 01:27 PM
New Health Care Law Upheld by Supreme Court – How Does This Affect the Economy?
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The Supreme Court upheld the March, 2010 health care law that requires purchases of insurance and requires health insurance to include more services.
This will go into effect in 18 months. The result will be that health care costs will rise because of increased demand. Many employers with under 50 employees may end coverage, thus forcing employees to pay for coverage. Healthy insured people will pay more to subsidize the unhealthy people who are now allowed to buy forced placement of health insurance.
Thus the typical consumer and typical taxpayer will pay more, resulting in less purchasing power for other things. This could hurt the economy, resulting in layoffs at businesses not involved with the healthcare industry. Possibly the extra income earned by members of the healthcare industry could be spent thus offsetting the reduction in demand caused by the higher healthcare costs. Possibly the health costs savings that formerly uninsured people realize when they get insurance to pay for their medical costs will allow those people more purchasing power for other goods. Some of the detriments such as reduction of purchasing power will be partially offset. The risk is that there will be huge frictional costs so that when Mr. A pays an extra $3,000 a year towards new health insurance mandates and Mr. B earns extra pay for working overtime providing health care the after-tax income B gets will be less than the costs paid by A and thus there will be a net reduction in consumer’s purchasing power for all types of goods, leading to a deflationary situation. The extra bureaucracy for health care will require hiring more lobbyists, lawyers, CPA’s, etc. and this could reduce the amount of discretionary income the general public has to spend on all types of goods. The extra income the elites (lobbyists, lawyers, etc.) will earn from these new frictional costs will go to them and not to the masses of people. These elites could save their paycheck instead of spend the money which would be deflationary.
Unlock secrets of Health Care Law
The new law requires taxes on investment income in addition to the other tax increases in 2013 that were due to the expiration of the Bush tax cuts. The new taxes will be deflationary, as any Econ 101 textbook will say raise taxes to cool down the economy, and reduce taxes to stimulate the economy.
The way that socialized medicine works is that the government is forced to cut costs by cutting benefits. In Canada someone was denied kidney cancer surgery for two years and finally they became so frustrated the patient paid $40,000 of their own money to get an operation in the U.S. In Britain the government insurance won’t pay $50,000 for Sutent, a kidney cancer medicine. Those that can afford the costs will pay out of pocket and this will reduce their purchasing power for other things, thus hurting the economy. Perhaps someday government controlled medical care in the U.S. will result in Americans going to Asia for medical treatment (that will be denied to them by socialized medicine), resulting in loss of jobs and taxes here.
I wrote an article “Establishment getting worried about the economy”.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Jun 27, 2012 @ 01:59 PM
To understand when will the economy get better one must understand how it will get better
For the economy to get better people need to pay down excessive debt, which is called deleveraging. This typically takes seven years. The process started with the 2008 crash but has almost stalled out and is proceeding at a very slow pace. The ratio of debt balances to income has grown steadily for several decades. Its growth was reasonable until the over-exuberance of the 1990’s bubble years and continued at unreasonable pace until the Lehman crash of 2008.
To recover from the recession unemployment needs to come down to the full employment number of 4% unemployment. This will happen through a combination of job seekers accepting pay cuts, moving to places where there is demand for labor and changing careers. The future growth of technology coupled with workers getting retrained for those jobs will be the key to getting out of the recession. To change professional careers it may take two years to choose a new occupation, two years to get ready for the training classes, another two or three years to get the credential, plus more waiting time due to unemployment. So a seven year period maybe needed for job seekers to transition into a more productive career. By coincidence it takes that long for society to go through deleveraging. Perhaps it is not a coincidence, since part of deleveraging may include getting a better career in a new location after having let the old house go into foreclosure.
A huge mound of cash is needed to pay down debt
The crucial mistake made in the Great Depression was that the government tried to prop up wages and prices, which needed to come down in. As long as they were too high then there was insufficient demand. Gradually wages did come down on a “real” basis and the job market reduced unemployment by 15 percentage points.
Today the U.S. is the only major developed country that doesn’t have the anti-business climate and problems of Japan and Europe. There are a huge number of skilled unemployed Europeans who would like to emigrate here. This will push down wages and prices, and will be helped by the U.S. huge supply of cheap natural gas and coal. This will allow the U.S. to take business away from the other developed countries and thus heal our economy.
The challenge that investors face is that the Fed Quantitative easing (QE) programs have created a stock market bubble, so stock prices are too high to be a stock buyer even with a gradual solution to the recession in sight. Corporate earnings are at a high water mark and could go down. The prudent thing for investors to do is to buy stocks only when the PE10 is below 10 which implies roughly an SP500 of close to the March, 2009 lows of 666 points. The best way to be a stock bull is to first protect your wealth with a temporary investment in bonds and then after a deep crash sell your bonds and buy stocks at good low prices. Stock and real estate bubbles can last for many years and get even bigger. The governments of the world have a conflict of interest because they can’t afford Keynesian deficit stimulus so they hope Central Bank QE programs will magically inflate the economy out of a recession. But all QE does is create misleading stock market bubble that will make people poorer when they make incorrect plans based on bubbles and lose the last of their savings in another stock crash.
There is great danger that the Eurozone could very soon get into deep trouble creating a world stock market crash just at the time the U.S. is facing a huge fiscal cliff at year end. For now investors should maintain a bearish position regarding stocks, commodities, and real estate.
I wrote an article “Economic recovery coming”.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Jun 26, 2012 @ 04:25 PM
What is the effect on "bond mutual funds" of stock crash?
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When stocks crash then interest rates go down, which makes bonds go up in value. When stocks crash business conditions are usually bad so investors flee into the relative safety of the bond market, making bonds go up in value. A stock crash may be a deflationary event which drives down interest rates, thus making bonds, with their fixed yield, more attractive, so bond prices may go up if their credit quality is very high.
A basic concept in investing is to keep an allocation of funds in bonds so that when stocks crash you can sell the bonds at a high price and use the cash to buy stocks at a low price.
The effect on bond mutual funds during a stock crash is that some individual bonds may be hard to sell due to their illiquidity, however, the shares of an open end mutual fund that invests in bonds can be redeemed at Net Asset Value from the fund company. Individual bonds suffer from a Broker-Dealer’s Markup-Markdown fees which can be roughly 1% for investors selling less than $100,000 of a bond at a time. It can be even greater percentage for tiny sales. This makes it much easier and less costly to liquidate a bond position by redeeming the shares of a mutual fund when stocks crash.
The concept that bonds go up during a stock crash only applies if the credit quality of the bonds are investment grade, preferably AAA quality. If the bonds are near the lower end of the investment grade rating they may go down in value due to fear that a recession could hurt the issuing company. There are two conflicting forces that affect bond prices during a stock crash: one is the desire for a safe haven from stocks which helps bonds go up; the other force is fear that a low quality bond could go into default during a severe recession and thus its value could go down.
Bonds can be a store of wealth during a deflationary stock crash
If your goal is to buy bonds as a refugee from stock crashes then you need to get investment grade bonds that have an AA or AAA rating. If you hold A or BBB quality bonds they could go down in value and then gradually recover after the panic subsides. If you hold AA quality they can go down in value during a severe panic. When Lehman went bankrupt that cause a panic selloff of quality bonds with AA ratings making them briefly go down by a small amount. These bonds recovered in a few months. During a severe crash leveraged investors can’t meet margin calls and are forced to sell good assets that they don’t want to sell so bond prices on investment grade bonds may drop even though macroeconomic conditions imply they should go up.
I wrote an article “Protect 401k from stock crash with investment grade bonds” and “Preventing stock crash damage to your 401k”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, Jun 25, 2012 @ 02:03 PM
Deleveraging is still needed despite lower interest costs
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The article by Mr. Scott Grannis claiming that deleveraging has been completed uses an incorrect concept. The article claims that one should look at the affordability of a loan payment that has become more affordable through lower interest rates as the measure of a sufficient completion of deleveraging, rather than looking at loan balances in proportion to annual income. While it may help some consumers to spend more if they refinance into a loan with lower payments it does not take care of the need to deleverage. Loans are a balance sheet item and should not be judged solely by an income statement item that the payment is lower. It is the income statement item of one’s income that allows a consumer to make progress on the needed goal of paying down loan principal (a balance sheet item), thus the ratio of income to loan balances is very important, even though balance sheets and income statements are two different things.
During the great real estate bubble people became deluded into thinking that artificially low payments from negative amortization loans or interest-only loans were acceptable. But that was wrong. Ultimately there is a day when loan balances need to be paid off or paid down, so the balance is important and not just the size of the monthly payment. Loans need to be fully amortized as they are usually tied to a project such as buying a car for personal use or a machine for business use. These assets have a finite life and the loan for the assets should be fully amortized to match that life. Thus we can’t simply look at lower payments, rather we need to look at balances and ask how can these record high balances be paid off if the earned income of the general public has stayed flat on a nominal basis and declined on a real basis in the past 12 years? During the past 12 years loan balances have increased at a very high rate with no increase in “real” (inflation adjusted) earned income. Ironically it was consumers’ lack of a “real” income increase that tempted them to borrow too much in the past 12 years.
Yes, some consumers will be tempted to look only at the lower payments as a reason to buy more things with borrowed money but the higher economic status, more affluent consumers are likely to have enough discipline not to fall for this and will instead look at their total debt levels including any debts tied to white elephants they are stuck with, and conclude that low rates alone don’t justify a debt fueled spending binge.
Open the doors to new ideas about finance
Today loan rates are very low so it may be tempting to think the lower payment means there is no need for deleveraging, however if you buy an asset today with hopes of selling it when rates go back up to normal levels then the new buyer who buys it from you will suffer from higher loan payments and may therefore request that the sales price be reduced to make it affordable. It is wrong to be tempted to buy more things on credit simply because the monthly payment has gone down; instead one must look at the big picture holistically. The total debt load of consumers plus their lack of a “real” increase in earned income means they need to continue deleveraging and also continue to save for retirement.
It may be true that corporate debt is often an interest-only payment schedule, but on the margin it is consumers and their debts that are the reason for deleveraging, not corporations. It is a misleading statistic if you suddenly save 3% of your income by getting a lower interest rate but you do nothing to pay down principal on a loan and simply rollover the debt balance. Ultimately consumers need to get their loan balances down to levels that existed about 20 years ago before the era of massive debt bubbles.
In addition consumers need to adjust their debt to what is appropriate for their age. The median age of a Baby Boomer is 55 and at that age people should be close to paying off all of their debt so that they can enter retirement debt free. However, today’s consumers have debt levels that are more appropriate for a young Baby Boomer in his early forties/late thirties who is going through an aspirational stage of life which involves lots of debt fueled purchases. This behavior would be more appropriate during the late 1980’s or early 1990’s, but not in today’s economy. Thus charts showing total debt balances in proportion to income need to be adjusted for society’s average age which means the debt problem is a bit worse than it looks.
I wrote an article “Housing not comparable to the past” warning that old economic paradigms have shifted and that simplistic rules of thumb about the ability to service and to qualify for a loan do not apply. The outcome of continued deleveraging is that it will increase the risks of a deflation depression cycle as consumers seek to pay off debt through sales of assets to a dwindling pool of buyers, or by default.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Jun 22, 2012 @ 03:18 PM
How will Moody’s downgrades of banks affect 401k investments?
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Moodys rating agency downgraded the credit rating of some major banks. Bloomberg had a funny article saying that the downgrader (Moodys) was downgraded by the market’s judgement since bank stocks went that day in a relief rally. (The market was relieved that it was not worse).
The problem with rating agencies is that they don’t dig deep enough into the hidden risks of financial companies. The problem with investigating a bank is that unknown loan losses in the future from an unknown future crash can hurt the bank’s profits. A bank is inherently a black swan investment vehicle where the bank is levered up 16 to 1 and invests in loans where the loan usually does not go bad until a few years after it was created. During the first year of a loan’s life the loan is paying interest and all appears well. Then in year two or three the loan becomes delinquent and then goes into foreclosure or bankruptcy. Thus the initial impression one gets of a bank that is making good income from loans is misleading because some of those loans will fail and this could sharply reduce the profit, maybe even cause a bank to fail.
401k investments could be hurt by a Moody’s downgrade of bank stocks because these banks could decide to boost their reserves in response to the downgrade. Boosting reserves is done by selling off profitable assets, reducing the amount of outstanding loans and thus reduces the bank’s profits in order to change the capital structure to has less assets and a greater percentage of equity. So if the banking industry shrinks its assets that means less lending will be available which will hurt the other types of companies, thus hurting all stocks in 401k’s.
Will bank stocks in 401k be as worthless as a coin?
The way to protect 401k from Moody’s downgrade of bank stocks is to own a high percentage of investment grade bonds (and avoiding bonds issued by European banks). Minimalize the risk of owning equities, commodities, and junk bonds by reducing your holdings of them.
I wrote an article “Preventing stock crash damage to your 401k” and “Euro debt crisis to damage 401ks”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Jun 21, 2012 @ 03:07 PM
Avoiding misleading real estate market benchmarks
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The media has run stories recently implying that real estate has finally bottomed out. The implication is that certain benchmarks such as price to rent ratio or new household formation or the cost of financing are at extreme levels that will justify an increase in house prices.
The problem with using old metrics based on the past is that the housing market was severely distorted in a way that is impossible for economists to deconstruct and reverse engineer so as to correctly predict future housing prices. The problem was that from 1984 to 2009 “Easy Qualifier” mortgages aka “Liar’s Loans” were offered by banks and this allowed a significant number of people to get homes they should not have been able to buy. Thus the data during that era is not useable for forecasting because Easy Qualifier loans are no longer allowed.
Economic research hobbled by corrupted or unavailable data
To fix this corrupted data economists would need to get the power of subpoena and get hold of a large random sample of old loan applications and then somehow get the IRS to release the borrowers’ tax returns and compare that to the incorrect income data on the loan application. This won’t happen because the IRS won’t release the data and because economists have no legal standing in court to go on a fishing expedition and subpoena old financial documents. So the amount of excessive lending that was facilitated by Easy Qualifier loans is unknowable. Then, even if this was known, the next problem an economist would face is that it is impossible to assess the impact when a group of rouge bidders are allowed into a crowded auction room. Will the rouge borrowers make prices go up in proportion to the number of rouge borrowers or will prices increase geometrically in a panic? For example if 80 people with money go into a crowded auction room and then 20 additional buyers get in who were not qualified to bid then this extra group of people could create a bidding war and push prices far higher than if the rouge group had been kept out of the marketplace auction room. By rouge buyers I mean those who got a loan that was more than they should have gotten because they used an Easy Qualifier loan to exaggerate their income.
The most important thing in lending and in investment valuation is the income analysis, so when lenders offered Easy Qualifiers they ruined the most important part of the loan process. Thus trying to compare home sales prices during the Easy Qualifier era to today is very difficult.
Anecdotal evidence suggests that lenders kept the worst excesses of Easy Qualifiers in check until 1997, after which time home prices exploded. By coincidence the real inflation adjusted personal income in the U.S. has been stagnant since 1998. Since homes bought by the bottom 99% of the population (unless a buyer is retired) are financed with a loan which is supposed to be qualified by income then it seems that home prices should be close to the 1997 (inflation adjusted) level to be fairly priced. This is because the last known era before Easy Qualifiers became extreme was in 1997 and from 1990-1997 prices dipped and then recovered thus 1997 was a time when prices could be deemed to be reasonable. Any appreciation since 1997 should be roughly in line with CPI of roughly 2% annually, so prices today should be only about 1.33 times 1997 prices.
I have seen a chart showing inflation adjusted home prices shows we are getting close to the 1997 real price level but still need to go down a little more. For a century on a “real” basis houses don’t go up faster than CPI.
Open doors to new ideas
Plenty of “demand” for housing but it is not real “demand”
Housing bulls say that there is a lot of pent up demand for housing and that the existing stock of housing is getting old. However “demand” must include the ability to buy something. Because many people are trapped in careers with stagnant or declining wages they can’t afford to buy a home that cost more than what they now own. Many young people are saddled with huge student loans, more so than in previous eras. Most importantly a large number of potential buyers can’t qualify for a loan because Easy Qualifiers are not available. Thus the alleged “demand” for housing based on household formation or the need to move to a nicer property is not real. Another example of a misunderstanding about demand is population growth. Most of it is with moderate to lower income people, while the upper middle class continue to have only one or no children per family. But moderate income people are suffering from a decline in “real” wages and excessive unemployment, so they are less able to participate in buying a house than upper middle class professionals with “new economy” skills.
Avoid the key mistake
The key mistake investors make is to look at high water marks in asset prices as a target for something that is going to repeat. That is an incorrect reference point, because a high water mark from a previous bubble could have been a false data point generated by a bubble, or a buying panic or it was caused by false perceptions about an investment. A more reliable benchmark is to use the income method of lending, which in real estate for homes owned by the bottom 99% is ultimately based on the earned income of the general population. The bottom 50% to 90% of the population has been stuck in a rut of no real personal income growth since 1998. So that means they can’t engage in a bidding war to buy a home even if there is the appearance of demand in the form of more household formation or a greater desire to move to a house in better condition.
The qualitative nature of earned income has degraded over the past 30 years. In the old days people got a base salary and that was it. Now people may earn a living as an independent contractor but due to fluctuations in income their income is shaky and thus it is too risky for the bank to loan money to them. This problem was fixed with the use of Easy Qualifiers but since 2009 these loans have not been available so many potential borrows can’t qualify. The shaky nature of their income means that they really should not be allowed to buy; the bank is doing them a favor to decline their loan request. The real problem is that personal income is more volatile and less reliable than 30 years ago so people are actually poorer than they think. It is like the Sharpe ratio for investments. When an investment is extremely volatile then on a risk adjusted basis it really was not that profitable, according to the Share ratio. The increasing less reliable nature of U.S. residents’ personal income means that (when using the income method of lending) less people qualify for a loan, which has been exacerbated by the end of “Easy Qualifier” lending.
Another inhibitor of demand is that the public needs to spend the next several years deleveraging by paying down debt. This means the public needs to either avoid buying a more expensive home or may even need to downsize and buy a less costly home.
Some exceptions apply
The exception to this article would be the upper middle class neighborhoods in coastal California where there is pent up demand where some people with excess liquid assets could use liquid assets to buy a more expensive home and where the desire to move into a Mediterranean climate is so great that people from all over the world are interested in moving to coastal California. A rough guess is that the desirable affluent areas with a Mediterranean climate are only about 3% of the U.S. housing stock, so this area is not reflective of the rest of the country. Another exception would be for the top 1% of the population who often live off of passive investments which have gone up due to the phony stock market bubble caused by the Fed’s Quantitative Easing. These people were hurt the least by the development of the “new economy” and have plenty of liquid assets so that they can buy a home without a mortgage.
I wrote an article “Why real estate forecasts are wrong” and “Housing not comparable to the past”.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Jun 20, 2012 @ 03:56 PM
How do I tell if my 401k is offering an investment grade bond?
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Examine your 401k holdings to see if they are investment grade bonds. The way to do this is to first find the five digit ticker symbol for the mutual fund choices for bond mutual funds offered in the 401k. Then Google the individual bond mutual funds and find out the name of the mutual fund family and go to the fund family’s website, then go to the web page for that particular bond mutual fund. The mutual fund company’s website should say what percentage of the fund’s holdings are in a certain credit grade and possibly give a weighted average of the total holdings. Unfortunately Pimco (a large bond mutual fund family) stopped offering this information in writing although they have given it me orally. It makes me wonder: why are they afraid to put it in writing?
Understanding letter grades for credit quality
For S&P or Fitch: grades AAA to BBB- are investment grade. Grades BB down to D are below investment grade. For Moody’s they use Aaa to Baa3 for investment grade and Ba1 to C for below investment grade. The rating agencies use “NR” for not rated. This could be a problem in cases where a large percentage of bonds in a mutual fund are “NR” then an investor doesn’t know what he is getting. See Wikipedia. Large, well established companies tend to get rated and smaller ones may not, so just because they are not rated doesn’t mean they are bad, but I would feel better buying funds that have a minimal percentage of NR rated bonds. However, the fund companies claim they can evaluate the credit risk of NR bonds.
Open the secrets to bond investing
The problem with grades is that they are based on the past; there is the risk that new circumstances could erode a company’s credit quality. The mutual fund company attempts to look out for the risk of credit quality downgrades before they happen but there is no guarantee that they will outsmart the market.
Other sources of bond ratings are Morningstar or other stock reporting services may publish a credit rating for a company, but this is not the same as a bond because each corporate bond has unique terms such as collateral or covenants to maintain certain financial standards. Large companies may have issued many different bonds under different covenants that could make the credit quality different from other bonds issued by the same company, so you can’t simply use a company-wide credit rating to assess the credit quality of a company’s bond.
The danger of blended credit quality in bond mutual funds
Bond mutual funds need to boost their yield so as to attract investors. They do this by buying junk bonds and diluting the portfolio with a mixture of 19.9% junk (below investment grade) bonds and 80.1% investment grade bonds. Then they offer the mutual fund as an investment grade bond fund. If you insist on buying mutual funds without using an independent financial advisor then you risk being fooled by the mutual funds. One strategy is to carefully read the fund company literature to see if they offer a commitment to very minimal holding of junk bonds. However, in today’s market it may be necessary for investors to take some chances with a small dose of junk bonds inside of a mutual fund that is primarily holding investment grade bonds. The way I evaluate that risk is to examine the corporate culture and essays of the mutual fund and see if they care about credit quality in an overall holistic sense or are they simply ruthless mercenaries trying to be a yield hog who seeks the highest yield regardless of risk.
There is the risk of a new recession later this year and that might result in lots of bankruptcies and short payoffs which would reduce the value of junk bonds. Investors should resist the siren songs of high yield junk bonds that could damage their portfolio. Instead investors should accept the reality of low yielding investment grade bonds with a goal of preserving capital until a huge stock market crash allows investors to buy stocks at good, low, fair prices, at which time one can bid farewell to the bond market.
I wrote an article “Six things you must know about 401k risks” and “Preventing stock crash damage to your 401k”.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Jun 19, 2012 @ 03:33 PM
Typical American’s securities investments did worse than the market in 2005-2010
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A CNNMoney analysis of new Census Bureau data median household net worth excluding home prices fell by 25% between 2005 and 2010, mainly due to securities prices which fell 33%. (A 7.98% annual decline in securities prices). This implies that people would have increased their net worth by 8% through savings (about 1.3% a year) if their securities had provided a zero net return. The Barclay’s Aggregate bond index returned 5.55% a year during this five year period and the SP500 returned 2.29% a year (mostly because of dividends). The spread or difference between the SP return versus the annual decline in the median household’s securities prices is 10.27% a year. This implies the average investor was buying high during a market bubble and selling low during a panic. If they had used an investment professional they might have been able to better weather the storms. The article did not say whether the securities prices were adjusted for dividends; the SP data is a total return data of which dividends were about 2% annualized. If Census data merely looked at prices and ignored dividends then the spread between what households made and the market’s price return was roughly 8% annualized, which is still a large amount when compounded over five years. The spread would be even wider if benchmarked against the return on a bond market index. This difference or spread reminds me of the Dalbar study for the 1990’s showing a similar huge gap in investment performance between the typical household versus a passive broad market index.
Open the doors to new investment ideas
The article also quoted Scott Winship, economic studies fellow at Brookings Institution "The median household is no wealthier than they were in 1984”. This reminds me of Japan where the devastation from the 1980’s lending bubble has made real estate prices fall back to levels of the 1970’s.
I wrote an article “Preventing stock crash damage to your 401k”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, Jun 18, 2012 @ 04:12 PM
How do you know that a financial planner is a fiduciary?
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To be a fiduciary an advisor must provide custom tailored advice for the client that is not a mass produced generic one-size-fits all solution. The advisor must not claim that he is merely engaging in a transaction (such as a Broker) but is advising the client. The Broker-Dealer community has tried to claim that they have the right to give “advice” in an “incidental” manner that is not the same as a fiduciary. So a prospective client should ask the advisor "are you merely giving me “incidental” advice or is the advice somewhat substantial, deep, big picture, long term planning type of advice?" Ask the advisor “what does the advisor do to make the advice custom tailored to my unique situation?” Ask them if they are a Registered Investment Advisor which is a different license from a Broker-Dealer license. A Broker-Dealer could argue that he was merely giving petty incidental advice and merely had to meet a simple “suitability” standard instead of a more thorough fiduciary standard. When someone in the investment business gives more than incidental advice then they need to register as a Registered Investment Advisor (RIA) and to be an RIA one is automatically required to act as a fiduciary.
The tricky situation is when a Broker-Dealer is dually registered as both a RIA and a Broker. In theory they are required to be held to the higher standard of a fiduciary. However, they may try to claim that some of the time they can “change hats” every hour or every minute with each customer or client and act merely as a transactional Broker who is held to the lesser standard of “suitability” (regarding investment recommendations) and then the next minute claim that they are serving another client in the context of being a fiduciary. So ask the advisor “are you, at all times, with all clients, a fiduciary and an RIA or are you, some of the time, with some clients, a Broker with no fiduciary duty?”
When your nest egg is at stake be sure to use a fiduciary
If the Broker's literature claims that he is merely acting in an "incidental" capacity in giving advice and is primarily a Broker doing a transaction then he is not a fiduciary. I think it is impossible for a Broker who is not also dually licensed as an RIA to claim that he is a fiduciary advisor since providing such advice would require an RIA license.
I posted a web page “Fiduciary status” about this topic. I wrote an article about a case where a Broker was not a fiduciary “MF Global lesson avoid margin trading”.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Jun 15, 2012 @ 09:32 AM
What does a Greek debt default have to with a 401K? A 401k is protected from bankruptcy, so if a U.S. debtor is in as much trouble as the Greek government and needs to file bankruptcy his assets in a 401k may be protected. Only a bankruptcy attorney is qualified to advise on these matters. Another parallel between Greece debt and U.S. student loan borrowers is that Greece should have had all its debts denominated in its own currency and never joined the Euro, then it would be much easier to discharge the Greek debt. The analogy to student loans is that U.S. students should have only borrowed a dischargeable loan (meaning something that is not a student loan).
Cosigning for loans is dangerous. Never, ever do it. When you cosign for a loan, if the borrower can’t pay, then you are forced to pay the debt. The borrower may forget to tell you that he has missed some payments and then your credit rating and credit score will be damaged for seven years. A new tragic story is increasing being reported about parents who cosign for a child’s student loan and when the child dies the loan must be paid by the parent and can’t be discharged by bankruptcy. This is truly cruel as the parent is suffering from grief, and may be very weak financially. It is unconstitutional because it is a form of indentured servitude.
Rather than obtain a private student loan that can’t discharged by bankruptcy it may be better for the student to get a job, develop the income needed to qualify for a loan that is not a non-dischargeable student loan and then get that loan. Later if the college graduate can’t pay the loan he can avail himself of the mercy of the bankruptcy court to discharge a debt that he can’t afford. If the borrower has been resident for a minimum of 40 months of Florida or Texas his owner occupied home is protected from bankruptcy. Retirement accounts are protected from bankruptcy depending on various factors.
In the old days getting a college degree paid off, but today getting one is a risky business proposition that may not pay off, yet the student maybe stuck with hundreds of thousands of dollars of debt that is not dischargeable in bankruptcy court. Unlike Greek government getting repeated bailouts from Germany, no one will bailout a college graduate who can’t pay his student loan. Instead the creditor will sue the borrower and say that the debt can’t be discharged by bankruptcy. By contrast, if the student had dropped out of college and borrowed money for an unsuccessful business venture then the courts would have no problem discharging the debt for a failed business. So students “investing” in a college degree should consider either limiting their education to the lowest cost public colleges, joining the military for a free education, or getting a dischargeable loan. They should also consider the demand for the skills and see if it is worth it to acquire so much debt.
Of course no one should deliberately borrow money with the intent to refuse to pay it back. Filing bankruptcy is a terrible thing because the court can take everything you have except some retirement accounts (assuming your home state has no homeowner’s bankruptcy estate protection) and destroy contracts such as a below market leasehold or a health insurance contract that you may wish to keep. A person who files bankruptcy may encounter the risk of being homeless, so this topic should not be seen as a harmless prank. Bankruptcy reporting lasts ten years on credit reports and it takes about two years to go through the court’s bankruptcy process so from filing to deleting it from the credit report is a 12 year ordeal.
401k accounts, IRA’s, 403b’s, etc. are protected from bankruptcy in certain situations with some dollar limitations. These limitations are subject to state laws which vary from one state to another.
This situation for U.S. students is a serious tragedy. The implications are that they will spend decades being a below par consumer who under-consumes and this means less goods and services will be sold and the economy will be slower because of their misery. Congress should change the law to make student loans as dischargeable as debts incurred by speculators and corporations. The constitution outlaws “cruel and unusual punishment”, so perhaps the Supreme Court can have a word on this.
A huge pile of debt.
A hedge fund could buy student loans using a bank loan to speculate in those assets and if the hedge fund went bankrupt that bank debt owed by the hedge fund would be discharageable in bankruptcy court, yet the student loans would continue to be immune from bankruptcy.
I wrote an article “Greek default risks damaging your 401k”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Jun 14, 2012 @ 05:27 PM
People want to know how to securely invest in a 401k, considering the risk that a Eurozone default could hurt a 401k.
The way the Greek debt default crisis will effect a 401k is that it would hurt European stocks, European bonds and would hurt the ability of the world’s economy to sell things to Europe which would hurt all types of stocks worldwide. The crisis will also make junk bonds go down in value and make AAA bonds go up in value. The crisis will cause something similar to a repeat of the September, 2008 crash where the world’s banks stopped lending and the world economy fell into a tailspin. However, because the world has so much more debt than in 2008 it will be harder to fix the world economy.
The crisis would severely hurt president Obama’s chances of reelection, possibly by inducing a rising amount of U.S. unemployment. His chances of reelection maybe only 17% because of the problems the U.S. economy is facing.
The best way to protect a 401k from a Greek default would be to assume that only investment grade bonds can survive the coming crash. (Remember in additon to Europe's problem's there will be a U.S. crash caused by the “fiscal cliff” tax increase of January 1, 2013, and by the preprogrammed drastic U.S. government spending cutbacks). In the typical 401k there is usually one mutual fund that is an investment grade bond fund. Google that fund and download and read its prospectus and other mutual fund company documents that describes that fund. There should be a one or two page “fund card’ on the fund company’s website that will say what the credit quality is for the fund’s assets. If investment grade it should have a grade of BBB or higher. Avoid funds that lack this. Be willing to accept a very low yield as the price to pay for safety. You will sleep better at night, when Greece defaults and the Euro breaks up, if you own investment grade bonds.
Don't let your 401k become worth as little as a coin
I wrote an article “Greek default risks damaging your 401k”.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Jun 13, 2012 @ 01:25 PM
Why the economy will eventually get better
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There have been a lot of gloom and doom stories in the news about homeowners with negative equity, or consumers with too much debt so that they can’t afford to consume. But a closer look shows there is a way out.
Regarding homeowners with excessive debt, if you assume 30% of the population needs to get a mortgage haircut or go into foreclosure to get rid of debt then a rough guess might be to multiply a 50% haircut times 30% of home mortgages. Mortgages are roughly 44% of all types of bonds. Most mortgages are sold by banks and repackaged as bonds or bought by Fannie and Freddie or pension funds. In an overly simplistic scenario an investor would have 50% of assets in bonds and 44% of that (22% of his entire portfolio) in mortgages. If the 22% in mortgages had a 30% default rate with a 50% recovery rate that would mean a 15% loss on mortgages or a 3.3% loss on all assets. If the bonds were held in a traditional IRA or 401k then the tax loss benefits would indirectly flow through to the taxpayer when he is retired and making withdrawals as he would have less to withdraw and thus pay less tax. So maybe his 3.3% loss becomes 2.5% after-tax. Considering how much stocks fluctuate, a 2.5% overall loss due to mortgage defaults would be a minor irritant to the owner of a diversified portfolio and would not change the investor’s consumption patterns. Of course his stocks might include bank stocks and some of them might go down in value, but generally banks sell mortgages to avoid risk, although they issue guarantees to some buyers so they might still lose something in a wave of foreclosures.
Problems can dimish into nothingness if people focus on goal setting
A chart showing inflation adjusted home prices implies that they have bottomed out because they are at the level just before prices exploded. If a typical home is worth $170,000 and if 30% of the owners can save 20% by going into foreclosure that implies someone could save $34,000 by going into foreclosure. But the damage to one’s credit rating and ability to borrow for the next seven years is probably not worth letting the home go into foreclosure or filing for bankruptcy. So at today’s home price levels it no longer pays off to go into foreclosure since many people are incentivized to avoid default because of the desire to have a good credit rating.
The other component of how to fix the economy is for individuals to take a second job and earn more money. The typical person has a net worth of four times his income. If he worked an extra 20 hours a week at a second job in eight years the extra before-tax income would be as much as his net worth. Taxes would reduce that but the compound return on his investments could help to offset the taxes. Persons near retirement could simply extend their working years delaying retirement until they had acquired enough to afford retirement. It may seem cruel to have to work long hours but doctors, farmers, business owners, and graduate level college students do it. If you really want a big goal you have to really work at it. The advantage of working long hours is that you become too busy and too tired to go shopping after work so you can save more.
The problems facing the country, especially the high rate of hidden unemployed people are still very serious, but at least there are ways the problems can be fixed.
Even though the economy will recover the stock market is an overpriced bubble. First a cathartic crash needs to occur bring the PE ratio down to 10 and then the market will be set for a boom. Stock prices at times may be very detached from fair value.
I wrote an article “How to solve the housing crisis”.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Jun 12, 2012 @ 04:05 PM
What asset classes have returned over 10% annually?
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People wonder about investment asset classes that are rumored to return 10% or more annually while the rest of the market, like the SP500 index, returned roughly 4.14% annually over the past decade (or -0.92% annually over five years). This is the reult of examining 474 asset classes in Morningstar with a 10 year history out of 502 asset classes. Of these, the top 44 (about 9%) had annual returns at or above 10%. The winning asset classes were Emerging Markets stock, precious metals, energy (oil) and bonds. Also the Alerian MLP index (MLP = Master Limited Partnership which serves the oil industry) came in the top 9% with a 15.4% annualized return.
Assuming that the bond markets ability to produce more capital gains is very limited with bond prices so high and assuming that the commodities boom may be over then that implies the only asset class remaining that has done double digit returns is EM stock. But that asset class gets a lot of help from the (probably ended) commodities boom and from the U.S. Fed’s Quantitative Easing which stimulated the EM countries rather than the U.S. At some point the EM countries may find they can’t sell exports to over-indebted deleveraging Developed countries and the EM countries will incur a lower growth rate because the easy gains from the initial phases of rapid development have been exhausted. Future growth in EM countries will be at a slower pace because their professionals now cost almost the same as Developed countries. EM countries demographics are starting to become closer to that of the slow growing Developed countries.
What asset classes returned a minimum of ten percent annualized?
One asset class, REIT’s, came in exactly at an annualized return of 10% and some variations of REIT's came in at just under 10%. The ten year history was influenced by the fact that 2002 was a recession so asset prices were depressed then. A five year history shows only 16 asset classes, mostly bonds, precious metals and Thailand stocks that made at least a 10% annualized rate of return. Since the economy was at a high point five years ago and has spent three years recovering from the crash of 2009 it seems a five year comparison is more valid.
If oil, precious metals, and bonds are unlikely to repeat their past ability to produce significant capital gains then it seems those investments that claim to be able to provide a total return of double digit rates are not going to repeat that rate of return.
One thing that investors misunderstand is Master Limited Partnership units. These are rumored to produce lucrative rates of return. But I see no economic reason why they can beat the market. Other than tax benefits that they get for their owners these MLP’s do nothing special that can’t also be done by other businesses serving the demands of consumers. They exist to serve the oil companies providing pipelines or oilfields. If the oil companies suffer from a crash in oil the oil majors could renegotiate the MLP contracts and reduce the compensation to the MLP vendor. The MLP’s run outsized risks of investing in fixed assets like pipelines or oil wells and can’t diversify either geographically or into other industries. Their annual rate of return is probably 1% higher than it would be if they had to pay corporate income taxes, so there is risk that a tax law change could take that away, which happened in Canada. The oil industry has a bad reputation of boom and bust cycles, so MLP investors could be left holding onto a white elephant during the next down cycle for oil. The oil companies are not stupid. They offloaded heavy capital equipment projects onto naive retail investors who bought MLP’s, so these MLP owners shoulder the risk of being stuck with immobile, illiquid capital assets during an era when businesses need to be flexible, nimble and practice “just in time” manufacturing techniques. Yes, I am sure the “Peak Oil” theory (forecasting an increasing scarcity of oil) will be proven to be true, but the question is which decade will it come true? Will the oil industry suffer a repeat of the price declines of the 1990’s for a whole decade and then take another decade to begin to recover before peak oil becomes proven to be true in 2035? The extra theoretical profit from MLP’s seems risky and unsustainable. The Morningstar energy sector index came in at 12.82% annual return for the past ten years versus 15.4% for MLP’s. The extra profit could be attributed to investors taking on higher risk that may not be fully compensated for. And part of their historical profit was a run up in asset prices as investors scrambled to buy high yield assets, so total return was only partly due to the current income produced by the MLP’s. If the price of MLP shares stays flat and all investors get is the current yield these assets won’t perform as they have in the past. The shocking drop in natural gas prices and now in coal and oil shows nothing is reliable in the energy business.
The one asset class that I expect to produce a 10% annualized return are U.S. stocks, but only if investors wait to buy them during a crash at a good, low, fair price. Based on the PE10 theory U.S. equities need to drop to 900 for the SP index to be fairly priced. Further, they should be bought a discount so as to provide a margin of safety, so perhaps waiting to buy when they retest the low of March, 2009 would be good.
I wrote an article “Increasing results using risk aware investing”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, Jun 11, 2012 @ 04:16 PM
Social Media tech bubble is like the real estate bubble
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The Wall Street Journal ran an article today “Silicon Valley Faces Private Sanity Check” about the concern that Social media companies are valued too highly. I have been concerned about this for a while.
It seems that some prominent tech stocks like Apple are propping up the SP index. If a handful of high achiever tech stocks suddenly burn out and go down then that could hurt the SP index.
If Social Media stocks are ultimately viewed as unsuccessful then that could influence other tech stocks and influence the entre stock market.
The business like reason for investing in Social Media is because they allegedly are a better way for a business to recruit clients either for free or by paying for ads. If businesses are unable to make this goal become possible then they will withdraw from Social media websites and the websites will go bankrupt. The Social Media boom in Silicon Valley began in January, 2011 and is going full blast. In the 25 years of working in Silicon Valley I have seen most successful companies fade to obscurity after a few years of glory. My concern is that three years after the current Social Media boom, by 2014, the boom will have become discredited and will retreat into mediocrity. Consumers are learning that they had better be careful what they do on Facebook to protect their privacy and they have learned to be reluctant to click on a “like” button on Facebook and have learned to be reluctant to buy advertised goods on Facebook. People have learned to be cynical about searching on Google because of all the spammy web pages trying to get unwarranted publicity. I think eventually businesses will decide that Social Media does not work in terms of being a way to market their company’s products. This means that Social Media as a business will fail and will evolve into something different, probably as a money losing attention getting subsidiary of a successful traditional company.
Tech stocks' future: will it be like the mortgage and real estate bubble?
Think of it this way: if all the businesses try to find new customers via Social Media where will those consumers get extra income with which to buy extra goods and services? This parallels the concept of the real estate bubble where people thought home prices would keep going up, yet they did not bother to ask how will new home buyers be able to afford to buy exorbitantly priced property. In both Social Media and real estate bubbles no thought was given to the ability of real live human beings known as customers or home buyers to actually afford to pay for and buy extra goods and services. The proponents of Social Media tell companies that they should get people to “like” their product on Facebook or place an ad on Facebook but there is no proof those strategies actually provide sustainable, profitable sales to companies. If every business places ads on Facebook then those businesses are not going to get any net gain in sales because of the competition between the businesses and because consumers don’t have extra purchasing power to buy more things.
I wrote an article “Decline in Facebook share price damages 401k”.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Jun 08, 2012 @ 08:51 AM
How to make a 20% rate of return
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Today’s market is dominated by investments that seem to make only about a 3 to 6% rate of return. What are some ways to make 20% annual return?
Write naked options on publicly traded stocks
These can yield 20%, but the risk is great that at some point a crash would occur making the option writer lose 45% of his cash deposit. For example, Apple (AAPL) four month Puts with a strike at the current share market price of 571 have an annualized premium of 24%. If the stock price drops more than 24% you would lose money. Writing naked options is very dangerous and is not recommended. Please don’t buy this.
Buy junk bonds using margin
The CCC rated index is at 12.9%. Assuming a broker will lend you margin money at 1.5% with 2 to 1 leverage then your yield would be 25.05% before commissions, dealer markup/markdowns, and capital losses (or capital gains). This risk is great that a stock market crash will be coming and since junk bonds correlate with stock then a junk bond portfolio could go down 45%. If levered 2 to 1 the investor would lose almost his entire equity. Please don’t buy this.
A huge yield - or a setup to failure?
Buy high yielding stocks using margin
For example Hatteras (HTS) is now paying a 12.6% dividend. If you borrowed funds from a stockbroker using a margin loan at an interest rate of 1.5% and levered up 2 to 1 (meaning use a 50% cash down payment) then you would gross a 25.2% yield less margin interest of 0.75%, which is a net yield of 24.45% before commission or capital gains or capital losses. The risk that a company that pays such a huge dividend may not be able to continue to pay such a high dividend is considerable; further the risk of the company’s stock price going down is great. The company uses tremendous leverage to purchase an inventory of loans. If interest rates rise the company will experience an increase in its borrowing cost that could result in dramatically lower profits and thus a dramatic fall in the stock price. It is possible that a high risk investment would not be eligible for a margin loan, so this is a hypothetical scenario. Please don’t buy this.
These things are very dangerous and are not recommended. I discussed them for educational purposes only, just like discussing earning extra money by working as a mercenary contractor in Iraq and Afghanistan. I wrote an article “Black swans now a regular in market” and “Berkshire losses 48% on junk bonds”. Yes, even experts who hate leverage get burnt by high risk investments. A Black Swan event could make these risky investments go way down thus destroying the leveraged investor. The pathway to riches is through caution rather than seeking high rates of return. If you lose money it is very hard to make enough to catch up with where you were before the loss. If a stock drops 50% from $100 to $50 and then rises 50% to $75 then you have lost 25%. Avoiding excessive risk is more important than chasing after a hope of windfall profits. It is even more important, if retired, to resist the siren songs of demagogues who advocate boosting yields with high risk investments.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Jun 07, 2012 @ 12:27 PM
Does Buy and Hold Investing Work?
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It only works if you first do the most important thing in investing and that is to only buy when prices are low and only sell when prices are high. Any investment can be good if bought at a low price and a good quality company can be a bad stock investment if its price is too high. A component of buy and hold strategy should be to only buy enough risky assets that you can afford to hang onto during a crash. That way you are not forced to sell at the bottom due to a personal crisis such as fear or unemployment, etc. This means having a balanced portfolio with plenty of cash or short term quality bonds (dry powder) to weather the storms.
Why buy and hold investing is popular
Investors and experts have become frustrated with trying to forecast the markets so they are tempted to seek a solution. They notice that after many decades the market continues to rise so they are tempted to think that a buy and hold strategy of refusing to sell during a crash is a good idea. While holding on during a crash is good idea, that idea alone is not enough to become successful. In addition one must buy only when the price is low. And one must strive to avoid loss, which is more important than seeking large gains. If you buy stock for $100 and it goes down 50% and then goes up 50% then the stock is worth 75% of what you paid so you lose 25%.
A huge pile of money in a balance sheet does not mean the company is a good stock
What is the way to determine when a stock is low priced?
A stock is not low priced simply because it is at historical lows. The old highs could be a false benchmark created by a bubble or a one-time lucky break that will not reoccur. The key to valuation is to not get too excited about balance sheet items such as assets or equity or book value. Instead look at income statement items. Use a five or ten year inflation adjusted average and filter out one-time or unsustainable items to get a clean data stream of the company’s income. Then find a multiple, like a P/E ratio, to estimate the value. The reason income is important is because it gives you have a constant flow of data points of sales and expenses over many years and it is really hard to make a large company grow faster than the economy (assuming it doesn’t purchase other companies), so the income statement is far more powerful and reliable than the balance sheet. A balance sheet contains assets that can suddenly become obsolete or decline in value or become illiquid but the liabilities are still there. A balance sheet has far few data points than a long term flow of five years of sales data. In addition, the reason a company has value is because investors want the earnings yield of the company. Rarely do people buy a company so they can develop allegedly dormant undervalued real estate holdings or sell off old capital equipment at a profit. By the time someone puts into motion a plan to develop dormant corporate asset holdings the economy could go into a recession and the new debt and expenses used to fix up and sell company owned real estate could hurt the profit from the sale.
What should I do now?
Examine your portfolio and get rid of anything that is overpriced or overvalued, even if means sitting in cash when cash pays less than inflation. Keep your powder dry and wait to buy (avoid owning stocks) while desperate politicians try to reflate the economy using monetary policy because they can’t use fiscal policy to borrow enough to re-stimulate the economy. The QEII reflation caused an unsustainable equities bubble; eventually the air will leak out of the poorly patched worn out tires and the market will go flat. At some point no amount of Fed pumping of air into a punctured tire will reflate the market.
I wrote an article “Tools for investing” and “bear vs. bull case”.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Jun 06, 2012 @ 04:21 PM
California and Wisconsin Elections Imply Big Changes Coming
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Yesterday the elections in California resulted in the passage of some important cuts of public employee costs by more than the needed two-thirds majority in San Jose and San Diego. Also, in Wisconsin voters reaffirmed Governor Scott Walker’s attempts to reign in excessive spending.
Former president Clinton said that Obama should continue the soon to expire Bush tax cuts, which is surprising to hear that from a Democrat. But it is not really surprising because Obama is in deep trouble with the unemployment rate which influences his low rating in the opinion polls, making the odds of his reelection very low. Therefore Obama must make drastic changes if he is to win reelection. One change would be to copy and preempt the Republican economic ideas like tax cuts, and reductions of public employee expenses in the hopes that this would create more jobs and a feeling of prosperity.
Regardless of what Mr. Obama does the political tides are turning in the U.S. in a way which is beneficial to free market stimulation of the economy and which almost no other major country except Canada is close to doing. This means that the world’s capital and expert skilled workers will flee to America as the Eurozone and Japan get weaker. This will produce a base to build bottom in the economy which will gradually lead to a new rebirth. This will be helped by the OPEC membership-sized huge surplus of natural gas from fracking in the U.S. which is not available in most other Developed countries.
Open up to new ideas
If the California and Wisconsin elections of last night and the probable November election of Romney somehow become like Thatcher’s 1979 victory in the U.K. then that may set off a generation long era of prosperity and growth in the U.S., assuming the new politicians have the courage to avoid caving in to demands for excess spending.
I wrote an article “Wisconsin election implies deflation”.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Jun 06, 2012 @ 12:31 AM
Govenor Scott Walker of Wisconsin survived a recall election tonight which was about his attempts to reign in excessive government spending. This implies that voters will seek to turn back the policies of excess government spending which could ultimately lead to lower taxes and greater economic efficiency. However, in the short run, since this would be accomplished with wage cuts and layoffs, this would be deflationary, so bond prices could go up and stocks could go down.
It is possible the Democrats in other states could copy and improve the policies of Gov. Walker, thus creating a national consensus to fix excessive government spending. This would make the U.S. the best major country in the devloped world in terms of fiscal responsibility. This will attract capital from other countries, raising the value of the dollar and the U.S. stock market.
I wrote an article "Republican victory effects on markets".
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Jun 05, 2012 @ 07:13 PM
MF Global Failure shows importance of investing in stocks and bonds and avoiding derivatives
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MF Global payments to its customers could take six years and may not be for the full amount owed to the customers, according to an article in Yahoo!Finance. The company went bankrupt October 31, 2011 and was regulated by the Commodity Futures Commission, so it did not have the SIPC insurance that stock and bond brokers have. An excellent article about MF Global is here.
Don't spend money on commodities
Are Commodities a Hedge Against Profits?
I have been concerned that commodities don’t really protect from inflation or diversify from stock market crashes. Now there is a new problem that commodity investing is risky due to inadequate investor protection, in addition to the long standing risks of tracking errors from Contango or Backwardation, risks of counterparty failure if using derivatives or ETN’s and risk of high fees.
I wrote an article “MF Global crash affects your 401k”.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Jun 05, 2012 @ 03:00 PM
How a Republican win will affect the stock and bond markets
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The sudden reduction in employment (where the jobless rate rose by 0.1%) on the Friday, June 1st release of the employment report implies that the economy is heading into recession. Since employment is the single biggest factor in voter dissatisfaction with an incumbent president then this means the odds are that the Republicans will win the White House and Senate elections in November.
How a Republican win will affect the stock market
The Republicans could cut corporate taxes thus increasing corporate earnings. Since stock prices are determined by either corporate earnings or a multiple expansion or compression of earnings (as in P/E ratios) then this could boost stocks. (My forecast is that regardless of who wins the elections that stocks are too high and will need to come down and retest the March, 2009 lows before they go up).
How a Republican win will affect the bond market
If the Republicans end stimulus programs, cut government spending and use the savings to pay down the national debt this could be deflationary which would make interest rates go down and bond prices go up.
Obviously there are two conflicting forces: if corporate taxes are cut with no solution for the increased Federal deficit then this would be inflationary and would stimulate the economy, leading to an increase in interest rates and a drop in bond prices.
The argument will be raised that, per “Supply Side” economics that a tax cut results in more revenue due to more activity being generated and less attempts by people to reduce their taxable activities. My intuition is that if taxes are at exorbitant levels of over 50% this could be true, however, if taxes are at reasonable levels then additional tax cuts may not produce enough revenue to pay for themselves, thus increasing the deficit. Taxes are in some ways very high when one counts all payroll taxes including the part paid by employers and when one counts all the parts of the tax code that were never properly adjusted for inflation (AMT, IRA's, capital loss deduction, etc.), and when one counts all the tax shelters that have been outlawed (1986 TEFRA act ended leveraged shelters). They will be even higher when the Bush tax cuts expire in 6.9 months.
Huge pile of money needed for deficits
Probably a Republican nominal takeover of the Senate by a margin of one Senator will bring minimal change because of filibustering, which requires a 60% vote to overcome. Most importantly the huge Federal deficit will greatly restrict the ability of any politician to cut taxes or increase stimulus programs. I doubt that the Senate would abolish corporate income taxes even though it would be a great way to stimulate the economy, assuming the publiclly traded "C" corporations were required to distribute all earnings to shareholders to be posted to their 1040 tax returns the way small business clsely held "S" corporations do.
Gene Epstein in Barron’s quoted the Center for GeoEconomic studies saying that the consumer confidence is a 67 rating and whenever the incumbent president experiences a rating below 95 he doesn’t win reelection. It is starting to feel like 1980 when there was a bad recession which severely damaged the incumbent resident’s chances to be reelected.
If a truly scary recession and deep stock market crash developed in late 2012-early 2013 that might motivate politicians to embrace supply side economics and cut taxes and thus the bad stock market crash of 2013 that I'm forecasting could be a cathartic event that changed the economy for the better leading to a new decade of a booming stock market that would be based on legitimate economic fundamentals and not on temporary monetary bubbles.
I wrote an article “Romney victory won’t fix the stock market”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, Jun 04, 2012 @ 04:38 PM
I wrote a blog post May 2, 2012 Avoid risky private loans. The article was copied in NAPFA Advisor magazine which is for advisors.
With the stock market and real estate market at risk due to problems with rising unemployemnt and Eurozone problems it is very probable that loan default rates will rise thus hurting the holders of private loans.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, Jun 04, 2012 @ 04:35 PM
Has real estate reached a bottom?
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Real estate for people who are not in the top 1% is funded by the buyer getting a mortgage, except for some retired people who already own a home with no debt.
Thus real estate values (with the exception of Silicon Valley or places where the top 1% live) is basically dependent on getting a mortgage which in turn is dependent on having a proper job to qualify for the loan.
The continuing degradation of the employment world where workers are forced to become independent contractors or become dependent on a higher percentage of variable income such as bonuses or stock options means that even if someone earns the same income as they previously did they will not qualify for a mortgage because the lender says their income is too unreliable.
Therefore housing values for the homes lived in by the bottom 99% may not have reached the bottom.
However, there is hope that a bottom could be reached if investors rush in to fill the void left by unqualified would-be buyers of owner-occupied homes. Today the rent as a percentage of sales price is in the 5 to 8% range in some areas so wealthy investors may want to buy rental real estate to get a better cash flow than that offered by stocks and bonds.
To make this happen in large amounts investors would need to overlook the fact that the invisible hand of the market usually rewards investors with a yield or total return that is several percent higher for illiquid investments compared to liquid investments. Also investors would need to overlook the huge frictional costs of owning real estate which include hiring contractors, suing bad tenants, Realtor marketing costs, Title and Escrow company fees, bank loan fees, city transfer taxes, incurring a higher property tax by giving up the benefits of California’s Proposition 13 when moving.
I think truly wealthy people learn fast about these costs and may decide the reward is not great enough to overcome the hidden or deferred costs. The convenience of owning liquid shares of publicly traded REITs or other assets versus holding illiquid real estate will probably hinder investment into real estate. Also most investment advisors are not comfortable with putting clients into illiquid assets since exiting those assets at a fair price may be impractical.
Recently it was announced that some home builders would from a REIT and have it buy houses. That’s an interesting idea but adding layers of costs can destroy the profit potential.
Ultimately housing will go up when owner occupants’ job income goes up during the next labor boom, which won’t happen until 2016 or even until 2023. Until then it will be a long hard slog of individual investors slowly buying a little real estate from distressed sellers. (I’m referring to the national average home and not to a showcase house in Silicon Valley).
You need a huge pile of cash to buy a Silicon valley home - but what about other areas?
The housing crash reminds me of a story about a speculator who watched a case of sardines go up from $5 to $195 to he bought some in wholesale quantities at $195. There was a crash, the bubble burst and the sardines went down to $5. He went bankrupt and was forced to survive by eating the sardines. He opened the cans to eat them, found they were rotten and demanded a refund. But the manufacturer said “sorry no refunds because those are for speculating they are not for eating”.
I wrote an article “Real estate valuations may be wrong” and “Housing not comparable to the past”.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Jun 01, 2012 @ 09:41 AM
Treasury rates plunged dramatically as unemployment rate increased. The employment report was released today showing unemployment rose 0.1% to 8.2%. Only 69,000 new jobs were added to the economy, far below the consensus forecast of 150,000. My forecast was 135,000. To overcome population growth a minimum of 125,000 new jobs are needed each month. Thus in “real” terms the amount of jobs decreased by 51,000, which is which the percentage of jobless people rose by 0.1%. Economists had hoped that three years after the 2009 bottom and with lots of stimulus that the jobless rate would improve. They were wrong.
We are in a pattern similar to the Japanese Soft Depression although there are many differences that make the U.S.far better off. With our entrepreneurial culture, our ability to attract talented immigrants, our vast resources of natural gas and coal and a huge skilled non-union workforce whose wages have steadily dropped we are the best country for capital to flee to which means we will eventually get out of the recession before others do.
America has more hidden resources than others
It is possible if the jobless rate continues to increase that the ten year Treasury could go to a 1.0% yield. At the yield today of 1.49% the ten year Treasury is risky because its price is high. However depressions last for a long time and the improvement needed to recover comes gradually so perhaps the danger of Treasury bond prices crashing is not the same as in the 1970’s when rising inflation made bond prices crash. A gradual economic recovery is not the same effect on bonds as an all out assult by inflation. However the risk of a crash in bond prices is something to think about. If the Fed started QE3 and got too aggressive at some point the bond market deflation vigilantes would defect over to the camp of bond market inflation vigilantes and then bond prices could go down. However, I don’t believe QE really stimulates the economy except to tease rich people into thinking they can afford luxury housing and other goods. At some point no amount of low rates will stimulate stocks or the real economy and then there is the risk that the Fed’s credibility will be broken. People have been trained like Pavlov’s dogs to salivate whenever the Fed lowers the rates but at some point it may not work and then people will abandon the stock market. I still expect a retest of the March, 2009 stock market lows when the SP was at 666. If today’s high bond prices scare you then shorten the maturity of your holdings but still stay in investment grade bonds. The volatility will get worse. Don’t buy stocks or commodities; wait for a repeat of the March, 2009 crash before buying “risk assets” (stocks, commodities, real estate). Keep your powder dry; don’t buy stocks on a dip, buy them after a Cat 5 economic hurricane has devastated things.
I wrote an article “Jobless rate to show no real improvement” and “Employment report to damage 401k’s”.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Jun 01, 2012 @ 08:02 AM
I attended the Financial Planning Association’s annual NorCal conference in San Francisco on May 29-30. The conference was excellent. Deborah Rauser gave a talk about Long Term Care insurance. The argument against LTC is that someone could self-insure and thus avoid the cost of premiums. The argument in favor LTC is that the need to liquidate $150,000 a year of assets to pay for LTC means that one’s portfolio is disrupted, their taxes will go up and they lack peace of mind. My opinion is that a key part of tax planning for affluent retirees is to keep appreciated assets and sell them only after death thus the basis is stepped up and no income tax is due on the gain. In Community Property states like California when one spouse dies the basis of the Community Property is stepped up to Market Value at death, even though one spouse is still alive. Thus if someone can avoid selling assets until death they can save on income taxes. Meanwhile the funds used for self-insurance will be taxed thus inhibiting the compounding of net worth. So self-insuring for LTC (meaning no purchase of insurance) means that one has an increased risk of not getting the best tax treatment regarding basis step-up an one is wasting money paying annual taxes on the compound growth of dividends and interest in the nest egg used to self insure. To get an LTC policy the insurance company requires that one is healthy with a good health history however the underwriting is less strict than other types of health qualified insurance such as Life, Disability, or Health insurance, since some health problems don’t cost an LTC insurer that much since the patient has a high chance of suddenly dying instead of spending years getting LTC. Medicare and health insurance don’t cover long term use of LTC. Remember LTC is care, not cure and health insurance is for seeking a cure. So to be properly insured one needs LTC, health insurance and if working, Disability insurance. In California some people pay $150,000 a year for care in a skilled nursing facility and could run up a $500,000 tab which could be paid for by selling $650,000 of stocks and paying a tax of $150,000 on the sale of stocks. The decision to self-insure means that with a smaller nest egg one will have less available for the other spouse’s retirement needs. Regarding the huge cost increase in LTC premiums that may be due to a huge decline in the lapse rate and to very low interest rates. These hurt insurance company profits, so they had to restructure their pricing.
I posted an article written by the FPA “With premiums increasing should you get LTC insurance?”
Investors should seek independent financial advice.