Posted by: Steve | October 27, 2009

Market Commentary: 10/26/09

“Uncertainty is the only certainty, and Learning to live with insecurity is the only security.”   

–John Allen Paulos

Date: 10/26/2009
Dow: 9,867

This current market situation as I see it:

It may be hard to believe, but the stock market has climbed 50% from it’s lows in March and is up 17% from January through September 30th. The question we are led to ask is whether this rally will continue or whether it will end. I think we can make the case that this spectacular rebound is similar to a tightly coiled spring being released after a full year of being pressed tighter and tighter. As soon as the economic stress started to normalize, the market sprung back sharply to a state of equilibrium. If this is the case, then we should expect a correction as the spring bounces back and forth finding a stabilized level. The reason is logical. Since when, does a market rise of such magnitude continue to climb without taking a without taking a breather? The answer….Never.

The real question today is whether the current decline signals a new downward path for the stock market or a simple and much needed correction. Only time will tell, but we do have a few clues we can use.

The Technical Point of View

I have been saying, based on technical research, that while we are now due for a correction, yet the intermediate term picture (3-9 months) continues to look good. Yes, we are seeing a few signs of weakening, but buying on dips is still a good idea.

For my day to day commentary on this, click the following link to join my Twitter Page.

The Fundamental Point of View

Looking at the economy and the world political situation, things seem pretty negative.  Tensions heating up over Iran and Afghanistan, the health bill in disarray and a surprisingly downbeat unemployment report have added to the worry among many things. Not all is bad, however. With low inflation and low interest rates, most economists are saying the GDP should grow 3-5% this quarter and 1-3% going forward. We also may be at the high point of unemployment which currently stands at 9.8%. Perhaps things will get better from here, not worse.

The Age-Old Dilemma

Investors are always faced with a quandary when forecasting the moves of the market in the short-term. You never know what will happen next so there is a bit of psychodrama that takes place with every market move. Since we are expecting a correction, allow me to illuminate the current dilemma

Situation:—Market moves down 5-10%:

The dilemmas:

1. You are afraid stocks will continue lower so you sell now only to find this was a temporary correction and you should have added to your investments.

OR

2. You have been waiting to buy-in because buying the dips has worked for the last 6 months, so you hold your nose and take the plunge and buy more, only to find this was the beginning of a next downward leg of the stock market.

There is no “best” answer to this problem. My strategy is to take an incremental approach to investing taking the emotion out of it as best you can. Thinking long- term, stocks are more likely to have a higher percentage return from these levels than they did at when the Dow was at 14,000.

But time is the key. The stock market is still the best mechanism for investing in the growing dynamism of capitalism worldwide. It is a MUST HAVE investment for your portfolio but like the mighty oak, it needs time to mature to its full potential.

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Posted by: Steve | October 2, 2009

Market Commentary: 10/2/09

Conscience Makes Cowards Of Us All—-And So Does Fear.

Date: 10/2/2009
Dow: 9462.46

The current market conundrum, as I see it:

The market has climbed 50% from it’s lows in March and is up 17% year to date through September 30th. It is obviously due for a correction and I wouldn’t be surprised if we were shaken out of our complacency to see a scary 10-20% decline. And why not?  Since when, can we expect a rally of such magnitude to continue without taking a breather? Think of the March to September rebound as a tightly coiled spring uncoiled after a full year of downward pressure.

Now that this spring has uncoiled we are back to a sort of normality. I hate to say “normality” because we all wonder what is “normal” these days. Bill Gross from PIMCO, calls this era, the “new normal” characterized by slow growth, the unwinding of leverage, low inflation and low interest rates—all of which he expects to continue for a while.

But I digress. The real question today is whether last week’s decline signaled a new downward path for the stock market or a simple and much needed correction. Only time will tell, but we do have a few clues we can use.

The Technical Point of View

I have been saying, based on technical research I use that, while we were due for a correction, the intermediate term picture continues to look good. This scenario has not yet changed as of this writing, but there is no question we are at a crossroads with regard to the near term direction of the market.

The bottom line is that upward market momentum, while still positive is weakening. We should have a better view this week and I will report this on my Twitter Page.

The Fundamental Point of View

Looking at the economy and the world political situation, things seem pretty negative.  Tensions heating up over Iran and Afghanistan, the health bill in disarray and a surprisingly downbeat unemployment report have added to the worry among many things. Not all is bad, however. With low inflation and low interest rates, (low mortgage rates if you can get one), most economists are saying the GDP should grow 3-5% this quarter and 1-3% going forward. We also may be at the trough of high unemployment which currently stands at 9.8%. Perhaps things will get better from here, not worse.

As usual, we never know what is going to happen next. If the market declines, we don’t know if it just is a correction or the beginning of a significant downward market move. The psychology goes as follows:

Market moves down 5-10%,

The psychological dilemmas:

1. You are afraid stocks will continue lower so you sell now only to find out you that this was a temporary correction and you should have added to your investments.

OR

2. You have been waiting to buy in because buying the dips has worked for the last 6 months, so you hold your nose and take the plunge and buy more, only to find this was the beginning of a nes downward leg of the stock market.

This is an age-old dilemma and there is no “best” answer.  My answer is to take an incremental approach to investing taking the emotion out of it as best you can. Thinking long- term, stocks are more likely to have a higher percentage return from these levels than they did at when the Dow was at 14,000.

But time is the key. The stock market is still the best mechanism for investing in the growing dynamism of capitalism worldwide. It is a MUST HAVE investment for your portfolio because, like the mighty oak, it needs time to mature to its full potential.

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Posted by: Steve | September 24, 2009

CNBC Appearance: 9/24/09

I appeared on CNBC this morning for a short segment about managing your 401ks.

Click on the following link to see the segment:

http://www.cnbc.com/id/15840232?video=1274849570&play=1

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Posted by: Steve | July 22, 2009

Market Commentary: 7/22/09

Click here to listen… 

A Brush With Bankruptcy

I want to tell you a tale. It’s a personal tale and one that should give pause to those considering bankruptcy due to current financial difficulties.
 
I started in the investment business in 1981. I was young and broke, like most young people and I managed to gain a position as a municipal bond salesman at a decent firm working for “peanuts” plus commissions. As time went by and I got a little smarter and better at my job, I managed to raise my status and join a major brokerage firm.
 
My compensation at the new firm was $500 per week for 6 months and pure commission thereafter. I had never earned the “whopping” sum of $500 per week so I was very excited. Right at that time however, we had just finished paying off my wife’s mustard yellow Plymouth Volare (boy did I hate that car!) and on the way to the Chrysler dealership to buy a new one, there happened to be a BMW dealership on the way. So I said to my wife: “Let’s just go in and see what they have”. Sure enough, three hours later, we walked out with a beautiful lapis-blue BMW 526.
 
Little did I realize that after the new car smell wore off, the cost of the monthly payment would just be the beginning of my struggle to afford this car. Standard maintenance was $500 a shot and unfortunately the air conditioner kept leaking pushing me into poverty at every turn. I had no business buying a BMW earning $500/ week, but the salesman was good at his job and he figured out a way to get me into this car. I was like the sub-prime borrower buying a $500,000 house; I was buying well above my means. Maybe it was the salesman’s fault after all! 
 
Luckily, I started doing a little better financially so I was able to keep up with all of this, but my life style started increasing as fast as my paychecks.
 
This went on until October 1, 1987. It was on that date that my wife and I decided to step up to a bigger house and mortgage. After all, my income had been getting larger along with the size of our family so it seemed like a good idea at the time. Unfortunately time was not on my side because exactly 17 days later, the stock market crashed, posting its largest decline since the depression– 22% or 500 points in one day!
 
This is when things started to get tough. It was my first experience with a bear market and investors were frozen with fear. My earnings slowed down considerably and the only way to keep up with my mounting obligations was to use whatever credit was available. So out came the credit cards and home loans. This went on for a few years and was not a pretty sight. Some of my colleagues were in the same boat, and a few of them decided to declare bankruptcy as a way of emerging from their problems. I considered it but was very hesitant. I didn’t know what the future ramifications would be, and I felt it was wrong to do it if I could find the wherewithal to pay my bills with the hope of a return to higher earnings as the situation improved. I believed in paying back what I owed.
 
The market, economy and my earnings eventually improved but it took a very long time to dig out of the hole I had dug for myself. To give you a small idea of how bad things got, I remember needing a new refrigerator but not having a spare dime. We went to Sears, filled out a credit application and sweated out the wait for approval. I didn’t know what I was going to do if I was declined. How would I live without a refrigerator? What had I gotten myself into? Thankfully, I wasn’t declined so the refrigerator was delivered the next day. What’s important about this experience, besides from the feeling of panic, was the fact that a year later, we sold our house and left the refrigerator to the new buyer. Incredibly, I hadn’t finished paying the refrigerator off, so I continued paying the bill for years, even though I was no longer using it.
 
Finally it dawned on me; (by that time I had studied and received my Certified Financial Planner designation) that the lesson to be learned from my trials was to understand the financial cycles that affected my life. I vowed that with the next economic upturn, I would not spend all of my money; I would start saving it for the next down cycle I knew would always come.
 
Finally with my bills paid off and extra money coming in the door, I built considerable cash and investment pile. I can only try to describe the profound impact that being ahead financially had on my life. My sense of security increased as well as my confidence and competence as a Financial Advisor. This was many, many years ago, but it was an important and hard won lesson which I carry over to this day-and it was a lesson which improved my life many times over.
 
So here’s an idea to help you learn the lesson which took me years to understand.
 
Divide your thinking into two ideas.
 
First, think about your personal financial cycle. Are things going well financially? Job secure? Money in the bank? Take a piece of paper and write the letter P for personal and an up-arrow next to it. 
 
Next, think about the economy in general. Is it bad or good? If it’s good, across from the P -up arrow- on the same line or in a little box write, E -up arrow. E for economy. There are four possible combinations: 

Personal:——————————— UP               Economy:——————————— UP
Personal:——————————— UP               Economy:——————————— DOWN
Personal:——————————— DOWN          Economy:——————————— UP
Personal:——————————— DOWN          Economy:——————————— DOWN

When your personal “P” is up, and the economy is up, save money for the inevitable down cycle.
 
When your personal “P” is up, and the economy is down, invest for the future
 
The worst case is Personal down and Economy down, because the two are inexorably tied together; i.e. out of a job (Personal) with jobs hard to find (Economy).
 
Remember the life of the farmer who is certain, as dark follows light, that winter will follow summer. He knows to save his extra harvest by canning or bottling it for the upcoming winter. This is the food which will enable him and his family to survive.
 
It is no different for us, just a little harder to see. Use my idea to simply chart the summer, spring, fall and winter of your personal financial life. Compare it to the economy as a whole and follow my aforementioned advice.
 
Oh and by the way, I decided to start my own business in 1996 to break away from the Brokerage business. When I applied to become a principal of my firm, a question on the form stood out like a sore thumb. “Have I ever declared bankruptcy”? Thank heaven my answer was no because the law does not allow one who has declared bankruptcy to operate a registered investment advisory company. My future would have been inexorably changed for the worse. This was one of the unexpected consequences that was not immediately apparent during those troubled times.
 
The lesson is clear. Be very careful, with big life decisions like declaring bankruptcy. While the reasons on the surface may sound valid and the path easy, you never really know the full ramifications of this type of action.
 
~Steve

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Posted by: Steve | June 24, 2009

Market Commentary: 6/24/09

A Trip Down Scenario Lane

 

All investors are compelled to guess the future direction of the economy and the stock market. Whether by gut feeling or the use of sophisticated mathematical algorithms, the future is not predictable and any attempt to forecast it is a futile enterprise. Past performance will give us no more insight into the future than crystal balls or astrology. Warren Buffett quips that if past performance were all that was required to be successful, all of the rich people would be librarians.  Furthermore, Wall Street types who forecast the market really have no more clue than you or me; however they compound their problem by giving pin-pointed forecasts which are wrong most of the time.

The Four Most Likely Scenarios

It is far better to approach this question by coming up with a list of reasonably valid scenarios that include the full range of economic outcomes and then try to attribute a rate of return for the market over the next 5 years. While not perfect, this can be done with some accuracy, due to the fact that we are forecasting a range of returns over a longer time horizon (5 years).

Scenario 1: “Muddle Through”

This suggests an economic recovery in late 2009 or early 2010 continuing with a less than normal recovery for several years. Also Inflation gradually rises.
 
Scenario 2: “Stagflation”

This also suggests an economic recovery in late 2009 or early 2010 and a less that normal recovery for several years. However it is followed by STRONG INFLATION in the 5-8% range near the end of the five year period.

Scenario 3: “Severe Recession Accompanied by Deflation”

This is a bitter scenario because it forecasts an extended and deep recession causing prices to spiral downward through 2010. The recession does end but the following economic growth is very anemic.

Scenario 4: “Goldilocks”

Everything is just right because the Government’s “kick-start” gets the economy growing in late 2009, followed by average growth with moderate inflation.

Since these are the four scenarios most likely to occur, the next question we need to ask is: What are the possible returns of the stock market under each scenario?

Before examining the chart, let’s get a little knowledge about a few of the numbers that appear in the first two rows.

First we want to add up all of the companies’ earnings that make up the S&P 500 and compare them to the price of the S&P. In 2008 the S&P’s earnings added up to about $501.  As of this writing the index of the S&P stands at just under 900, therefore a simple math calculation puts the price as a multiple of earnings to (PE) around 17. Just to reiterate, this means the average company in the S&P 500 sells at 17 times its earnings.

Now this PE multiple thing is not a static number. A lot of things like interest rates and inflation among other things can affect it, but our research forecasts the following earnings and PE ratios under each of the four scenarios. The chart below organizes all of this and forecasts possible returns based on a given price level of the S&P 500.
  Blog Chart.6.24.09
 
 
Look at the left hand column under “Starting S&P 500″. Go down to the number of 900 which is where the S&P 500 is at the current time. Following across, one can see the possible returns under each scenario. Under the Muddle Through scenario, the possible future annual return of the S&P 500 over the next five years is 5.2%. Under the Stagflation scenario it’s 2.7% For Deflation it is between -3.5% and .5% and under Goldilocks; 13.9%. (Hurray for Goldilocks).
 
Realistically, we don’t know which scenario is going to work out so to be extra careful, we would want to buy the S&P 500 at a lower price just to build in a margin of safety.
 
Move up to 800 on the left hand column and the numbers start to look better, but not ideal.

During the latest  sell-off which occurred in March of ‘09, the S&P 500 dipped to 680. I don’t think we will see the 680 lows again but I do think 750 is a good possibility, so let’s look at that.

The possible future returns at 750 range from .05 to 18.5%. If we eliminate the extremes of deep painful recession and a goldilocks economy, we are left with returns in the 7% to 12% area. This is a decent return and one that will create real wealth for those with the patience and fortitude to stay invested. This return won’t come easy, however. Remember I’m forecasting an average annual return. The word average sounds safe, but it is one of the most dangerous words in the investment vocabulary.
 
“You know it don’t come easy…”  
– George Harrison
 
For example, it can be said that if you have your head in the oven and your feet in the icebox, your average temperature could be 98.6o, but of course you will probably not be around to measure it.

The same is true for investing. To get an average rate of return of 10% you will probably have to experience annual volatility of 20% and maybe more. That means that the range of returns in any one year could swing by 40%. This is not for the faint of heart and as we saw last year, many were not able to stomach it and keep their faith about the future.

There we have it; an idea of possible future returns under four economic scenario at numerous price levels of the S&P 500. This is not crystal balling, nor is it wild guessing. In my opinion, since one of these four events will actually occur, we can choose our entry back into the market accordingly. We can control our investing destiny rather than having the market or our emotions control us.

This is the essence of successful investing and the essence of wealth creation.

Steve…
 
1Source: Standard and Poors

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Posted by: Steve | May 28, 2009

Market Commentary: 5/27/09

Click here to listen…

I am always searching around for good ideas, and when I find them I send them along to you. This one was written in 2006, by “JLP” and it’s quite good. The title of this post was inspired by Stephen Covey’s best-seller: the 7 Habits of Highly Effective people. 
  Steve……
 

 The 7 Habits of Highly Defective Investors 

1. They don’t have an asset allocation plan

We’re all familiar with the common wisdom that says that 90% of a portfolio’s performance is determined by the portfolio’s allocation. I don’t know if that is true or not, but the fact remains that having an asset allocation plan and sticking with it through rebalancing, makes a lot of sense. Why, because it brings discipline to the investing process. When a portfolio has an asset class that performs extremely well compared to the other asset classes in the portfolio, human nature tells us to the sell the poorer-performing asset classes and buy MORE of the asset class that just performed well. In reality, we probably should do the opposite and sell some of the appreciated asset class and buy more of the underperforming asset classes.

2. They invest for the short term, using long-term investments

Stocks, a long-term investment, should only be used for goals that are more than 5 years away. Although it may be tempting to meet a short-term goal with a hot stock, it is never wise to do so.
 
3. They check their portfolio’s value too often
 
The reason this is a bad habit is that constantly thinking about one’s portfolio tends to give the portfolio a short-term feel, which can lead to short-term decision-making.
 
4. They get stock advice at cocktail parties
 
Although it might be fun to trade hot stock tales at parties, it can be hazardous to a portfolio unless the tip is followed-up with lots of research.
 
5. They are envious of other’s successes

This ties in with the last point. Listening to a person brag about their 60% return can make anyone envious. However, keep in mind that they probably are leaving out some important details such as the fact that all their other stocks are in the toilet. In other words, congratulate them and change the subject.

6. They watch too much CNBC

I’m not saying CNBC is a bad thing. However, I am saying that too much CNBC can turn a long-term investor into a short-term trader. Consider changing the channel or cutting back on the business news.

7. They pay TOO MUCH in fees

I cannot stress enough the importance of keeping costs down when investing. For the most part, the more an investor spends in fees, the less they will have at retirement.

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Posted by: Steve | April 17, 2009

Market Commentary: 4/6/09

Click here to listen…

Been Down so Long it Looks Like Up to Me
                                           –Richard Farina

The Current Dilemma.
 
Now that the stock market has rallied, investors are in a quandary. Should they continue to hold stocks and hope to recoup more of their money back, or should they sell into the rally in the hope of avoiding more carnage if the market falls once again? They ask themselves: “What if this is just a rally in a continued bear market? They would be right to think so, just look at the chart below.

Chart 1

 chart2
 
Every single market rally was followed by a decline, some benign and some quite vicious (August 2008 -December 2008). The same thing happened between 2000 and 2003.

Chart 2

 chart

 However, instead of continuing its downward slide like most experts forecasted, the market entered a new bull phase lasting until November 2007. Chart 3 shows the rise starting in 2003.

Chart 3

 another chart
Putting It Into Real Dollars

If the value of your 401k or IRA stood at $500,000 on October, 2007, it would have declined to $225,000 by February 2009. One month later, the value of your investments would have been grown back to $275,000 (Using the S&P 500 as our proxy).

Therefore any rally as represented in Chart 1, would have represented a selling opportunity. For example, by March 10th 2008 your $500,000 would have declined to $415,000. By November 17th, it was valued at $254,000.
Just like the 2003 period, we never know if the previous bottom is the final bottom. Unfortunately, looking at the past does not give us enough information to predict the future. Like driving, looking only in your rear view mirror, the past may give clues, but its ability to forecast is limited.

Is There Any Way To Cope With This Uncertainty?

Yes, but the first thing to do is take a fresh look at today’s environment. Put the past behind you and look forward. Ask yourself if the economic landscape has changed since those dark days of 2008?

I would have to say that compared to the terrible events in October and November 2008, we have seen positive changes in financial markets. It is just a flicker of change, but change nevertheless.  I know, a flicker is not a flame and a few drops of water do not make your glass half full, but notable changes are taking place. Here is a short list:

1) The Government has stepped in and backed nearly everything.
2) Banks now have new rules regarding the pricing of their bad assets.
3) Banks are starting to lend again. As a matter of fact, Bank America just announced they are re-entering the jumbo mortgage market.
4) GMAC, the financing arm of General Motors, also said Wednesday that it would resume making loans to subprime borrowers in order to spur sales.
5) The decline in orders for a number of companies is beginning to flatten out; suggesting the rate of decline is slowing in many cases.
6) Production in increasing in China.
7) The stimulus has not even started yet.
8) Interest rates are at historic lows.
9) The price of oil is showing signs of life.

The jury is still out and many economic challenges remain and many smart people continue to predict the economy will get worse before it gets better.  However, there is a sense on my part, of an end to the free-falling economy and stock market.

How Does One Make A Decision Under These Stressful Conditions?

One way is to try and determine if the stock market is “under-valued”, “over-valued” or “fairly-valued”. A person I respect, who has studied valuation successfully for many years is Jeremy Grantham, head of GMO. (Click on the link to find out more about him). Grantham uses a simple investment idea in a sophisticated way to determine “fair-value”. He also understands there will be times when the markets will go too high and too low relative to “fair-value” and he knows that what goes up will eventually come down and vice versa. He calls it “regression to the mean”.

The chart below shows the performance of the “DOW” from 1965 to 2007. The straight line going up the middle is the trendline or average. The tech bubble is the area above the trendline between 1998-2001. Interestingly, after the big decline in 2002, markets did not go below the trend line, indicating a move back to fair-value. The market rose again until 2007, declining dramatically bringing the market to what  appears to be a significantly “under-valued”. This is a simplistic picture and not meant to directly reflect Grantham’s calculations, but it does illustrate the point.

its the last chart 
 
Grantham thinks fair-value is currently around 900 on the S&P 500 (The DOW is not a very good measure of the market anymore). Today the S&P 500 stands in the lower 800’s, having sunk to a low of 675 on March 9th, 2009.

This is information we can use. We can be more assured of success buying below the trendline than either at it or above it. The only problem, as Grantham has experienced on more than one occasion, is the curse of being TOO early. These trends of over and under valuation do not change overnight. Sometimes they can last for years and be quite frustrating.  If the market is over-valued and you sell, it can continue higher and make you feel you are losing opportunity. If the market is under-valued and you buy, it can become even more under-valued making you feel you have made a big mistake. During the period between 1995-2000, Grantham shouted loudly that the market was severely over-valued and was deemed dead wrong for 3 years. He stuck to his guns however, and even in the face of losing many accounts, he was eventually validated. (Warren Buffett often suffers the same fate).

Today, while everyone is screaming the “sky is falling”, Grantham is buying stocks during the deepest of the market declines. He can do this because he is willing to be wrong for periods of time thinking he will eventually be proven right.
My job is a bit different. I must take a more exacting course because my first concern is to preserve capital.  Instead of grabbing the extreme bottom or top of the market, my philosophy is to grab the middle two-thirds thinking that it should be enough to create wealth over the long term.

To this effect I remain cautious but poised at the trigger to enter at the “right” time.

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Posted by: Steve | March 6, 2009

Market Commentary: 3/2/09

Click here to listen…

The Doom and Gloom of it all…

Many investors are now asking when their stocks will get back to even.  My response is always; “What do you mean by even? Is it the amount of money you initially invested, or is it the amount that your investments were worth on the day the Dow hit its high on October of 2007?” Human nature, being what it is, the answer is usually the latter: the value at its high. We all tend to anchor on the highest number we can remember.

Think of your house, for example. You probably remember the price your neighbor’s house was sold for during the very good times. I know I do. My house was originally purchased for $215,000 in 1996, and I remember seeing it worth over $500k as other homes sold in my neighborhood at that price. (Of course, they didn’t have the extra features my home had). When I looked up the value of my home on Zillow.com the $500,000 value was further reinforced.

I understand my home is now worth somewhere in the neighborhood of $300-$350,000 which is a decline of 30-40%. Yet, from my initial purchase, my home is still higher in value by 40-60%. If  I’m not selling, how important are these numbers to me?  Important in mainly one respect. What we all want financially from owning our own home is for the value of the home to keep pace with the cost of housing in general. In other words, in order for me to have enough flexibility to move to another home, I would need the capital from my first home to be close to the capital needed for my new home. If prices are rising, I will have more money to pay for a new house whose price has also risen. If I was renting, I would not have the money to pay for the higher cost of a new house. Fundamentally, home ownership enables us to keep pace with the rising (over time) cost of housing in the United States.

You might say: “Fine Steve, but that’s your house, what does this have to do with my investments?” I suggest it’s very much the same thing.

Think of your 401k or IRA for example. Values were much higher 16 months ago (I’m sure you remember THAT number) and yes, today’s value is lower, but are you spending any or all of that money right now?  If you’re not using all the money today, it’s like staying in your home. It doesn’t really matter what its worth this day or this year. It will only matter when you are ready to spend it all.

You may reply: “But, I came into the market late and the current value of my 401k is LOWER than all of my monthly contributions combined! I don’t have the satisfaction of seeing the value of my 401k worth more like you do with your house.”

True, but what is the real effect on you? In hindsight we know now that the values 16 months ago were high and perhaps the future rate of return from those high numbers will not increase much for the next 5 years or so, but the future rate of return from today’s prices, should be MUCH higher.

Let’s look at the stock market. The Dow reached approximately 14,000 in November, 2007 and let’s say from that point, stock prices rise at a rate of only 3% per annum on average. (Not a very good return from the 14,000 level.) If this is true, the level of the Dow will be 17,734 in 10 years. With the Dow now around 7,000, the annual rate of return from 7,000 is 9.75%. This is far better than 3% you would earn if you did nothing, so you can see the benefit of continuing to invest when prices are low.

Of course nothing is ever this simple and there certainly are unknowns. Maybe the market won’t appreciate 3% over the next 10 years from the 14,000 level (even though history suggests a high probability that it will earn more.)  Nevertheless, right now you only have to beat the 2.5% return you earn on your risk free investments like CD’s or Treasuries to be successful. That, I think should be relatively easy to accomplish.

How then, do you weather this awful downturn? 1) Turn off financial TV. (…except when I’m on, of course.) 2) Suck in your belt and get your emotions under control. Think past this recessionary cycle. Investigate the downturns of 1973-75, 1980-82, 1990-91, and 2000-2002. You’ll discover each one of those periods felt scary and different from the previous recessionary period. Experts lectured about the end of capitalism or the irreparable damage to America’s position in the world. These lectures and conjectures continue today.

Remember though, if you didn’t buy into their negativity back then, you likely would have profited very well, and chances are, doing the same in these days of uncertainty will profit you very well indeed.

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Posted by: Steve | February 19, 2009

Market Commentary: 2/16/09

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The Cycle of Market Emotions

There is a psychological “sea-change” taking place before my eyes and I am beginning to recognize a sense of fear I haven’t seen so far in this cycle. Many I talk with, think the stock market is headed for a huge fall and absolutely want no part of it. I can understand their fear, but this is starting to feel like the beginning of one of the big mistakes people make when the news is at its dreariest. Allow me to explain.

There is a natural cycle to any “risk” type of investment. Whether we are talking about Gold, Real Estate, Foreign Securities, -even the bond market. As markets rise, people become hopeful and encouraged. They may start to buy-in as they notice the economy and the stock markets improving. This is natural and healthy. As the markets continue to rise, hope turns into optimism and excitement as their earlier decision is reinforced by the rising market. Every new investment is rewarded with a higher value a few weeks or months later. Investors are feeling very smart while being constantly reinforced by the news of improving fundamentals. Companies are hiring and expanding and profits are rising. They are also growing domestically and internationally and Countries, which historically have had impoverished financial systems, start improving bringing wealth to many of their people who once had little hope of a decent material life. All is good. So good, in fact, that now new people are entering the market trying to get in on the action.

Let’s examine Real Estate as a recent example. As interest rates declined and home prices rose, more and more buyers entered the market with sound fundamental reasons behind their purchases. Homes were affordable and rising prices reinforced their decision that the home purchase was a good idea. This continued for many years reaching a point where prices rose well past reasonable fundamental value.  By the time speculators entered the market, people were predicting ever higher prices, due a rising economy as far as the eye can see. This had real estate investors stirred up to the point of euphoria and hysteria.

It continued for a relatively long time, well past the point of rationality and reason. Investors just continued to focus on rosy news reports and rising prices until just when everyone involved reached the maximum point of euphoria, the music stopped. This point of maximum euphoria is the point of maximum financial risk. In other words, when you are feeling that investing is easy and low risk, and you are feeling most secure and assured, investing is at its riskiest point and the probability of high future returns are low.

What has this got to do with today’s investing environment? You might be wondering why I’m talking about rising markets when we are in a completely different part of the economic cycle. Prices are low and seemingly continuing lower. Nothing good is being reported by the media and now, even the White House is forecasting doom unless they get their money. In addition, I am starting to get panicked calls from clients and others who think they should be out of the market at any cost.

This is the cycle I just described turned on its head. Let’s see how we got here.

In early 2008, prices began to weaken and the market became more volatile. Investors felt a little anxious, especially as volatility picked up, but the experience of the last few years had demonstrated to them that holding on would be the best thing. This was not unreasonable. Stock prices were nowhere near their highs, relative to earnings, as observed before the dot com crash of 2000. The economic news was still pretty good and while there were some difficulties in the mortgage sector, the FDIC, the Federal Reserve and the Treasury Department seemed to handling things in an orderly manner.

But the news began to get worse and fear rose amongst investors when in October and November Wall Street began to unravel. Banks were in need of huge infusions of cash, brokerage firms were crumbling under the weight of bad investments and too much leverage and access to credit became so restricted that borrowing virtually ceased. The Stock Market had a heart attack.

Fear rose to desperation and panic as the news started to get pretty bad regarding the economy and everyone finally opened their statements and gasped. So now investors’ fear factor started rising but no one really wanted to sell into that great decline. Now, a few months later, clients tell me about so-called sophisticated investors who are saying they are pulling out of the market. I am hearing from liberal radio that the Bush administration didn’t tell Obama how bad it really was and conditions are much worse than they appear. CNBC is full of experts making prognostications about the rest of the year and, day after day, the front page news tells the facts about a deteriorating economy. This feels bad and people are discovering that successful investing is hard to do and can be high risk.

I am suggesting that while this condition can go on for a while, we might be near the flip side of the cycle I described earlier-the opposite of euphoria. Remember I just said the following: “When you are feeling that investing is easy and low risk, and you are feeling most assured, this is the time when investing is at its most risky!

Now I am saying that in these times when investing is hard and seems very risky and you are most fearful about your money, it is the time when investing is actually safer and more rewarding in the future.

That is why Buffett and others are buying today.

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Posted by: Steve | February 2, 2009

Market Commentary: 2/2/09

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Introducing Your New Partner, Mr. Market

Let me tell you a story about two partners that went to work together every single day. The first partner, you could say, was the operating partner; let’s call him “Mr. Operator”. He toiled a full day, growing and managing his business in a very diligent manner. The second partner did not operate the company, but he was the guy with the money. He was the investor; let’s call him “Mr. Market”. Mr. Market would talk to his partner, Mr Operator, every day without fail, since the very first day of the business. Each day Mr. Market would offer to buy the business at a price he thought represented the future value of the company.

However, there was one caveat. Mr. Market suffered from manic depression, and like most manic depressives, he was elated for periods of time and hugely depressed for others. On the days he was feeling most positive and optimistic, he would offer a sky high price assuming the future prospects were unlimited. On the days he was depressed, he would offer a very low price, afraid that Mr. Operator would unload the company at too high a price.

This went on day after day after day. Even though Mr. Market was the money guy, Mr. Operator was a smart guy too. He really understood his business and had a good idea of what is was really worth. He never took Mr. Market’s offer price as an indication of the value of the company. He knew that one day he would sell to Mr. Market, but it would only be at a time when Mr. Market was in his overly optimistic, manic phase. You see, he knew what the business was worth, so he could choose the price at which to sell. He knew that Mr. Market’s price was based more on emotional factors than on facts.

All investors who buy and sell securities in the stock and bonds markets have Mr. Market as a partner too. As the operator of your investments, you may choose to buy-from or sell-to him at his stated price, always aware that the choice is yours. You see, it’s up to you to know the value of your business, never confusing the price that is offered with the real value of your investment. It may or may not be the true value, but it is up to you to know.

Since the beginning of 2009, Mr. Market has been quite manic. As expected, Mr. Market was feeling pretty good. A new President, a new congress, the promise of change lifted his spirits and his view of the future. This is a common occurrence at the beginning of most new years, and in true form he offered higher and higher prices for a few weeks—just a few weeks, because soon his mood began to darken once again. He started concentrating on the negative. Yes the economy was bad, and the media was sighting statistics that described it in detail, but Mr. Market acted confused, and couldn’t make up his mind from day to day. One day, he would push up the price for companies and the next day he would push them back down like a see-saw. Day in and day out he has been acting this way for the entire month. If news hits the screen about the fall of “New Housing Starts”, prices go way down. If another report surfaces about a rise in the number of houses sold, the market zooms higher.

If you are an active trader, you have to decide whether you are willing to trade with this manic depressive, not knowing what mood he will be in- on any given day. Or you can sit on the sidelines and wait for him to present an offer to you to buy something at a low, low price. If you do decide to buy from him at a low price, you can now wait for the return of Mr. Market’s overly optimistic periods. You have to know what your business is really worth and you can choose to sell to him on your own terms.

Right now, I choose to wait on the sidelines until Mr. Market gives me an offer I can’t refuse.

Looking at January

Concerning January’s performance, I will share with you some thoughts and insights from Sam Stovall, Chief Investment Strategist, Standard & Poor’s Equity Research:

The S&P 500 fell 6.4% month to date through January 29. This would be the second consecutive year in which the S&P 500 declined during the opening month of the year. Since 1929, there have been five other times that the “500” tripped up in two successive Januarys (1956-57, 1973-74, 1977-18, 1981-82 and 2002-03). In the remaining 11 months of the second year of these “double-dips,” the S&P 500 gained an average 3.0% and rose three of five times. But don’t get your hopes up too quickly. Twice the market fell in January three years in a row (1939-41 and 1968-70).

Why should we care if the S&P 500 rises or falls in January? Because of an old Wall Street adage, first observed by The Stock Trader’s Almanac that states: “As goes January, so goes the year.” A positive performance by the equity markets in January has typically led to a gain for the full year, while a negative performance in the first month usually signaled a decline for the entire year. Of course, past performance is no guarantee of future results.–Sam Stovall, Global Equity Strategy, January 29, 2009

What to do now.

What am I doing? I’m culling the herd, so to speak, getting rid of the weakest investments. I am buying bonds at 6+% and dabbling in the preferred stock and junk bond arena, getting yields of 11 and 15%. These investments are riskier, so consult your advisor before doing this on your own.

Stock wise, I’m still on the sidelines having ended my “phasing in’ strategy earlier in the month due to negative technical readings.

At this moment, there are no signs pointing to a rising stock market, which leads me to the conclusion that the next few quarters might be rough.  However, many stocks remain at historic lows and any sign of a bottoming out of the economy will, in my opinion, send these stocks soaring once more.  Patience will be needed and patience will be rewarded.  In the words of a better philosopher: “Patience is bitter, but its fruit is sweet.”–Rousseau.

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