Posted by: Steve | January 21, 2010

Breaking Up Is Hard To Do…Why Selling Our Stock Market Investments Is Against Our Nature

Americans Love to buy stuff. We love to consume. As a matter of fact, we love to consume so much that we are even categorized as consumers.  I don’t know how you feel about being called a consumer, but I have always felt a little insulted.  Nevertheless, every AD we see, every “pitch” we hear is dedicated to the proposition that our needs, and desires will be filled if only we buy something. Buy, Buy, Buy!

It’s the same for investing. Turn on the TV, and you hear “buy this stock, buy that stock”. Pick up a magazine at the airport, and it’s, the “10 Stocks to BUY Now”, the “10 Best Bargains for 2010″ or “New Stock Market Strategy for Buying.” And so on.

You know what’s missing? It’s the message about when to sell. With investing in the stock market, the easy part is always the Buy decision. It’s the natural thing to do. Investors, by and large, are optimistic people and it fits in well with our view that conditions will always improve over time. The economy will grow and by “owning” stock market investments we should be able to participate in this growth.

I am in this camp. If you have heard my thoughts before, you would know that I am eternally optimistic and I believe there is good reason to be so. The economy DOES grow over time and good companies will on average, be able to tap into that growth and create real wealth for shareholders.

But that is only half my point today.

Our sunny attitudes and our natural propensity to buy stuff, can lead to investment risk management troubles if we don’t learn how to sell.

Selling is hard. It is an exercise that may not end in optimism. It makes a pessimistic statement. As a matter of fact, selling can be like a break-up. It is the end of something. Now I don’t mean to exaggerate this too much, but suffice to say, selling our stock market investments is against the nature of many of us and the sooner one realizes this, the better investor they will become.

Why is this my topic today? I am currently and reading a book entitled “It’s when you sell that counts” by Donald L. Cassidy. This book was originally published in 1991 and it contains some very wise stock investment advice on this very subject.

Let me share an example with you. Ask yourself if this isn’t you. Have you bought a stock only to see it decline right after you bought it? We all have. What is the thought process at this particular time? Well, all is still intact, the reason I bought it has not changed, and in fact since I just bought it a few days, weeks, months ago, how could I have not seen a change coming? It will come back, this is only temporary. XYZ is still a great company, I mean it is one of the largest companies in its industry and it has a history going back to the -18th century. And that dividend! It’s great!

Pick your reasons for justification. Maybe your investment strategy is, “it’s different this time”. Internet stocks are going change the world and this is the best name in the business. Bio stocks are leading the way in health care.

By the way, the company I was talking about which had a great dividend and has been around in some from since the 18th century is Citicorp. In 2007 this stock sold for over 50 per share, paid over a 5% dividend and was considered one of the best banking institutions in the world. Today, it is 3.5 per share, pays zero dividend and has become a back-water player in the banking industry.

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Posted by: Steve | January 6, 2010

Market Commentary: 1/6/10

While everyone is looking ahead to 2010 in an attempt to peer into the future direction of the market, I suggest we would be vastly better off doing no such thing.

Look at all of the investment predictions of all of the so-called gurus and you will know what I mean.

Statistics show, the forecast accuracy of the guru’s is no better than 50%. Flip a coin and you would get the same result. Half the forecasters were wrong and half were right, but more importantly, can we look to those who have been right and see if we have enough “juice” in their accuracy to make bets along side of them?

Unfortunately, not really, Jim Cramer, 46%. Bob Brinker, 46%. Ken Fisher, 58%. Louis Navellier, 54%.

Even the top performer had a margin of accuracy of only 63%. This is the TOP guy!

What about our greatest economists? Do I have to spell out Greenspan’s legacy or Bernanke’s abilities of prediction? They are flawed, very flawed.
Nouriel Roubini, who some have come to call “Dr. Doom” called the decline in Real Estate to a tee. He seemed to forecast the terrible decline of 2008 and 2009, but has missed this current economic rebound and stock market increase by a mile.

Don’t get me wrong. He is a very smart guy, I mean a very, very smart guy. He’s just human and really has no idea what the future has in store. Peter Lynch, the famous and successful money manager of the Fidelity Magellan fund wrote, the reason he thought he was so successful was  that Fidelity did NOT have an economist on the payroll.

Warren Buffet has always warned about the folly of forecasting and said numerous times he has no idea what the market will do. In fact he says he doesn’t need to know and it doesn’t matter to him. If he purchases great companies at reasonable prices, the market will eventually reflect the value of the business and his fortune will be made.

This is not to say that research, experience, smarts and effort can’t get you somewhere. It just means that it is not a human ability to foretell the future. Events can move in a particular direction for a particular period of time, but we cannot tell when some other event that we are completely unaware of will intervene and change everything. For instance, did anyone see the internet coming? Google, Amazon, Ebay, Apple. How could anyone of us know these would be the survivors who would change our world so much?  Political events, Iraq, Pakistan, Al Qaida, Russia’s resurgence China’s growth, India’s expansion. More and more. No one can tell what wonders and tragedies tomorrow will bring.

So what do we do? How can we get anything right if we can’t know what is going to happen and prepare for it to capitalize on?

The answer is simple and beautiful. You don’t need to know the answers to these questions. You don’t need to know or do anything about incidents or outcomes or upshots or consequences of things under which you have no control.

You need to know what is under your control and make the right decisions.

For example, can you live within your means? Can you save to the best of your ability? Can you direct your attention to things that COUNT in your life rather than things that give you only short-term gratification?
Now I’m into short-term gratification as much as the next guy, but that is AFTER I have taken care of the important stuff.

So this year, here’s what I think…

If you want to invest in stocks, make sure you have a 5 year time horizon and GET INVESTED. Forget what might happen over the next few months. It’s immaterial.

Make a plan that if the market should take another dive, even if it is ferocious, you will commit some reasonable amount of money to investing in it. Just keep your eye on the horizon and your ultimate goal.

Don’t put all you money into the market. Rather, look for other reasonable opportunities. A new business you can afford. –Most REAL Money is made by starting your own business.

Keep diversified.

Don’t buy any stock you hear about through a neighbor, broker, insurance agent, barber, bartender. You get the drift.

Make a list of what is in your control and what is not.

Remember that all things are cyclical, so if the economy is bad and you are okay—meaning you still have a job, and money in the bank that can take you through 6 to 12 months of no work. Don’t save your money at 1-2% like everyone else is doing.

Invest it. Remember we are due for an up cycle. Buy when everyone is selling. Invest when everyone is saving and save when everyone is investing.

That means, when the market has been up for a while, and the economy looks great and all is good, take some money off the table and put it in secure savings accounts. This way, when the economy starts to turn and IT WILL…you will have money safely tucked away ready to invest when everyone else is panicking. You will finally be buying low and selling high, like you are supposed to.

This is how real wealth is created.

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Posted by: Steve | January 6, 2010

Santa’s Lament

T’was the week before Christmas and all through the house
all investors were worried to report to their spouse

That Santa would not be coming this year
‘cause his workshop’s  got notice  it was in arrears.

Seems Santa got greedy and financed his “dive”
Just at the time in two thousand and five

When prices were up, and had gone through the roof
And his business was booming so he needed no proof

That the trend would continue –and the bank would be blind
‘cause of sugarplum bonuses all on their mind

So they gave him the money and he hired more deer
But the problem with Santa –was he worked Once a Year!

No income of sorts just the shop he had going
and the deer and the elves but no profits were flowing!

And the shop’s market value had just hit a double
it all seemed so easy -there was no sign of trouble.

And then, with a shutter and sounds like a rumble
The value of everything started to crumble

Then launched a descent that provided a scare
Not seen since the days of a young Fred Astaire

Now, Lehman, then Merrill, now Citi then Bear
Then Wamu and GM the signs were all there

That the piper was playing its song of despair
That this time the system may be-b’yond repair.

But then came the Fed with its pail full of cash
Doling millions and billions to ward off a crash

With Geithner and Ben and the Dems on the aisle
Doling money as if it could go out of style

And just when the light at tunnel’s end was unclear
We saw hope in the name of “Green Shoots” which appeared

To begin a revival of sorts, some would say
A survival of sorts some would say on this day

And now with the chance it won’t happen again
We look with some hope toward Two Thousand and Ten

To getting our fiscal affairs in some order
To paying the billions of debt owed to China

To hope that the Gov doesn’t add to our stress
And allows us to grow our way out of this mess

But so I digress……

And what of poor Santa, that man who’s so jolly
Whose outlook is sunny and not prone to folly

Well he did alright cause his home did inspire
 a bid from a couple, yes a first time homebuyer!

But truly it’s sad that an era has ebbed
Cause Santa has mastered the biz of the web

And like eBay and Google and Facebook and Twitter
Santa’s new site is considered a winner

With overnight shopping and shipping no cost
His deer are retired and his elves are laid off

Only Donner and Prancer and Rudolph are willing
 to help at the times when backorders need filling

But Santa remembers and though he’s alright
He misses the thrill of the children’s delight

He misses the workshop and laughter and noise
He misses the thrill of inventing new toys

But of all things he misses
 It’s the chance to recite:

“Happy Christmas to all, and to all a good-night.”

All Content © 2009 Steven L. Pomeranz, CFP® and Pomeranz Financial Management All Rights Reserved.

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Posted by: Steve | December 16, 2009

Market Commentary: 12/16/09

Click here to listen…

Listeners of my radio show and readers of my blogs are always asking my opinion about gold. Is it going higher? Is it too high? Curiously, they are often ready to spout their opinions before I have shared mine.

It goes something like this: “Steve is gold going higher? Because, you know, with all of the new money the US government is printing it seems inflation is just around the corner. Don’t you think we should be back on the Gold standard? Because, you know, the dollar has lost so much of its value over the last 35 years”.

My response is usually, “Of course what you say may be correct, but there are no easy answers and understanding the true value of gold is especially troublesome.

Gold is affected by any number of factors; like its fabrication into jewelry and its role as a “storehouse of value ” in many countries around the world.

A few weeks ago I discussed an article from a well regarded expert at KIMCO, the large gold trading company, who stated he saw the real value of gold in the $600 to $850/ounce range versus the $1,000/ounce it was at the time of his article and the $1,100/ounce it is trading for around the time of this writing.

I further stated that due to the invention of the new exchange traded fund (GLD) which directly holds gold bullion to back up the share values, investors of all kinds can buy gold as easily as buying any common  stock. Furthermore, you can do other “stock” type things with this new security like going short(selling gold you don’t own in the hope of buying it back at a lower price)  and borrowing money to buy it. This expands ownership in the metal by enabling more investors to get in the game. This  also means that sophisticated speculators can get into the game as well which further changes the fundamental dynamics of gold ownership.

All of this new activity leads us to ask new questions in order to truly understand what is going on. The most important question in my opinion, is whether the current price of gold accurately reflects its “true” or inherent value or is trading at a speculative price. This is not an easy question to answer but it is the most important question to ask.

As I stated before. the analyst at KITCO believes gold is now trading in a speculative range.

So, if gold is a speculative investment, does it mean you shouldn’t buy it? Not necessarily, you just  need to understand that investing right now is more risky and dangerous than it was in the recent past. Can money still be made? Yes, without question. In my opinion, I think the price will continue to rise, but be sure you understand that you are investing at your own peril. Here’s what I mean; As we have seen time and time again, lots of money can be made speculating as long as you are no longer invested when things go sour. Like driving at top speed in a sports car, all is well, all is fun, and all is good-up to the very last second when you hit the wall. Then as we all have seen, it can all end badly.

What is the “appropriate” way to think about investing in this precious metal without “hitting the wall”?  For the answer to this I want to share with you the ideas of Jeff Clark, Editor, Casey’s Gold & Resource Report
(http://seekingalpha.com/article/177692-how-to-predict-the-price-of-gold). He suggests keeping your eye on the U.S. dollar index; “This six-currency gauge of the greenback’s value has dropped 7.8% so far this year (as of December 3)”, meanwhile, gold is up 38.7% year-to-date. In other words, for every 1% drop in the dollar index, gold has risen 4.9%. If that approximate percentage holds over time, one can begin to estimate what the gold price might be if you know what the dollar might do”.

He continues; (the numbers quoted are edited by me to make them more current).  “Today, the US dollar index stands at 76.49. If the dollar were simply to return to its March 2008 low of 71.30 next year – a 6.8% drop from current levels – this would imply a rise in gold of 33.3% and a price of about $1,495 an ounce.

Over the very long term we can calculate the long term value of gold IF these ratios stay the same. Its simple math, maybe a little too simple, but let’s play with it anyway. If you believe the dollar will lose half its value from current levels, this would imply a gold price around $2,807. Just increase the price of Gold by 5% for every 1% decline in the dollar index.

Clark states;  “Unless you think the dollar’s problems are solved, its eventual demise is gold’s eventual glory”.

One glaring problem with Clark’s idea is that these types of mathematical relationships change over time. Any specific ratio (in this case, 5 to 1)  is good while it works, but since the ratio will change over time, it gives you very little insight into future prices. In other words, today’s ratio will be tomorrow’s curiosity. Beware of overly simplistic ideas.

To summarize, buying gold today is more speculation than investment. It may continue to rise very much like growth stocks did in the late 90’s,housing in 2005 and oil in 2008. Unless you are a particularly nimble speculator, keep your eye on the intrinsic value and focus on capital preservation.

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Posted by: Steve | November 11, 2009

Market Commentary: 11/4/09

Sometimes they (the media) get it and sometimes they don’t. This time the Wall Street Journal is getting it right. While the market reacted soundly to the better than expected GDP numbers last Thursday, jumping 200 points, the quality of the GDP numbers were questioned. Most of the jump in the economy was due to consumer spending, which is generally a positive thing. However, the gist was that the numbers reflected the two major stimulus packages put forth by congress and the administration. The 8k first time homebuyers tax credit and the cash for clunkers.

Without these two government interventions, the growth of our economy would have been much slower.

So what is the GDP anyway? It is devised with a relatively simple formula: Consumption (of the private sector, you and me) plus business investment plus government spending plus the difference between exports and imports. In other words, if exports grew by 15% and imports grew by 16%, the result would be a decline of 1% of the proportion that exports and imports make up the economy.

GDP = C + I + G + (E – I)

So the debate is on. Is this recovery different from previous post recession recoveries and is it one that could sustain itself if the government stopped providing all of this stimulus to us?

The answer from the majority of economists seems to fall into the “no” camp. Which is the economy would not be doing to well if it hadn’t been for governmental stimulus. The consumer just isn’t feeling all that confident right now and needs to have a strong financial incentive to make any big moves.

However there was some good news that should be emphasized from the GDP report. Reported, was a large increase in exports, brought about, in large part, by the lower dollar which makes the price of our goods to foreign customers very attractive. Cheaper prices to foreigners have boosted the revenues of companies like Caterpillar and Intel.

However, the 15% increase in exports was offset by a 16% increase in imports as Americans still continue to buy imported goods.

There is a certain feeling however, and this is the important trend developing that might be changing the course of this recovery. And this is the point I want to draw your attention to. The Asian Basin and other developing countries are performing much differently today than in the past and have kept growing at a strong pace. It is entirely possible that the long awaited export boom to developing countries might be the in the making, replacing the softness in consumer spending in the US.

One example is the recent activities of UPS (United Parcel Service). According to the WSJ, UPS has been investing heavily as it gears up for what it expects to be a trade-led recovery, even though third quarter profits fell 43% from a year earlier, It is in the midst of spending $1 billion to expand a sorting facility in Louisville, Ky., and is planning to open a new facility in Shenzen, China. UPS has stated that it very much believes that the recovery from this global recession is going to be led by global trade and the projects that have been sacrosanct…are the projects that support global trade and support export volume across the world.”

So don’t be too negative. Yes, the US economy will probably remain soft for a while, but the seeds of a new boom in manufacturing and technology business in the US may be germinating.

Remember that no one can see that far into the future. Remember that in 2001, when all tech companies and dot coms were collapsing and many experts were announcing the death of companies doing business on the internet, a small company came from out of nowhere and changed everything. Want to take a guess which company I am talking about?

Google, of course. So, stay positive on the future and invest accordingly.

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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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