Bert Whitehead, M.B.A., J.D.
Finally we have seen some positive news on the financial front, and many optimists think we have hit the bottom and the stock market bounced off its low-point. It’s nice to be able to take a breath from the brutal onslaught of bad news over the past year.
We have been preaching about the dangers of being out of the market, even when it is falling, While it has been psychologically stressful to maintain equity positions over the past year, recent market activity points to the reason to refuse to market-time.
Interestingly, the average gain for the S&P 500 in the 1 year following the low close for the 8 bear markets that occurred in the last 50 years is +36.5%. The current bear market is the 9th bear market of the last half century. The closing low point (so far) of this 9th bear market was 677 and it took place 7 weeks ago on 3/09/09. In the last 7 weeks, the S&P 500 has gained 28.5% (not counting the impact of reinvested dividends.
Our clients pay us to ‘watch their backs.’ So without being an outright pessimist I think that we are still in a perilous financial situation. The future of the auto industry is teetering and we may see 2 of the ‘Big 3’ bite the dust in the next few weeks. The economic reality goes even deeper than that. We are restructuring our national economy to be able to participate in a global economy.
Our prosperity over the past 15 years was based on a world-wide spending spree, fueled by cheap credit and over-leveraged real estate. The current government nostrums are designed to spur more spending, but no meaningful programs have addressed the banking and real estate collapses. We see the impact of these issues everyday in the ‘For Sale’ and ‘For Lease’ signs in almost every neighborhood and commercial area.
Each client’s situation is different, and so the approach best suited to you depends more on what is going on in your own life. If the breadwinner in your family is out of work, or you have kids in college, or are faced with disability, or are retired (or hope to be soon) – these are the key factors in your investment allocation. While the stock market may look great, it is a mistake to be kicking yourself for having missed out on the steep increase recently.
For clients in transitional or distressed situations, we want to maintain an extra cash cushion. If your life situation is stable and your bond ladder is on-track, dollar cost averaging into the stock market is very advantageous. Now that tax season is over, we have scheduled appointments with each client to review your portfolio and make adjustments as appropriate.
It is a mistake to conclude, based on the past 2 months market activity, that you should now jump in with both feet. It is likely that we may not hit bottom until next year, and then it may take a couple of years to fully recover. Market timing is a futile waste of energy.
Treasury bond rates are low, and the feds are buying bonds to keep long term rates down, so it will be advantageous for many clients to refinance at lower rate (unless you owe more on your house that it’s worth). Jumbo mortgages (i.e. more than $417,000) however still carry very high rates and it is seldom worthwhile to refinance those.
This experience of living through the worst economic period since the Great Depression of 80 years ago will have a lasting positive impact on most of our clients. The losses will ultimately be recouped, and we are able to outlast even a continuing downturn. More importantly it has made many of us aware that we were frittering away money on things we didn’t really value. This lesson I think has to be re-learned by each generation as we discover that our Schwab statements aren’t the scorecard for our real wealth.
Monday, April 27, 2009
Wednesday, April 8, 2009
Best Case vs. Worst Case April 2009
Bert Whitehead, M.B.A., J.D. ©2009
How will this recession play out? I like to ask people that question (although many of them think I should know). I have noticed a strong correlation between a person’s economic outlook and their political leanings. The extremists on both sides focus on certain factors in the global meltdown to support their point of view. I’d like to examine the extremes on both sides and explain why both an extreme positive or negative outlook is at best a very remote possibility.
The Best Case: The Stimulus plan works as designed world-wide and the economy bottoms out at the end of this year. The rebound is very rapid so that the stock market is back up to 13,000 by the end of 2010 and unemployment drops to 5% and we all sing “Happy Days Are Here Again!” The government devises regulations for banks and oil producers with congressional oversight to control their profits and pricing. Taxes are raised on businesses, investors, and high income earners to pay for energy, education, and health care services while lowering the deficit with the increased revenue. Increased government spending causes inflation which threatens to get out of control.
The Worst Case: The worldwide economy reels toward collapse with the US government selling bonds to provide money to support an ever-expanding list of government-provided entitlements, bailouts, and subsidies. More pressure is applied to other countries to follow our lead, resulting in rising stagflation worldwide and hyper-inflation in some countries threatens to spread globally.
Gross Domestic Production world-wide drops precipitously. Higher tax rates to target the most productive sectors of the economy result in less total government revenue as sales and incomes drop. Small businesses close, or start operating under-ground. Unemployment rises and pushes the world into a global depression. Protests and crime increase as populations become more impoverished. War looms.
The Truth: Neither of the two above scenarios are going to play out to the conclusion. This economic cycle will end and we will recover at some point. Stimulus programs may do more harm than good, but we are not going to become a socialist country. The dollar will not collapse and putting all your wealth in gold or another currency to avoid being wiped out is nonsensical..
There are simply too many economic factors at work to be able to determine the outcome. Most changes in a free market are self-correcting, e.g. as the dollar weakens, more foreigners want to buy US goods, services and real estate, which ultimately strengthen our economy and the dollar rises again. Supply and demand result in short-term price swings as markets seek balance by testing the extremes. Lower beef prices mean more people will start eating beef, and then ranchers will grow more steers. The outlook is further clouded by completely unexpected events such as a California earthquake, or a war in the Middle East that shuts down 50% of the world’s oil supply.
Most readers of this blog have already been impacted by this recession, and those who haven’t yet are likely to be in the next year. The worst reaction, however, is to bank on an extreme scenario. It is just as foolish to sell everything you own to buy gold because some writer ‘proves’ that hyperinflation is inevitable. It is folly to put all your assets into real estate because it’s so cheap now, and you believe that the big turnaround has already begun. Home prices are still dropping, and I remember the wisdom of my father: “Son, never try to catch a falling knife!”
The proponents of both extremes have personal agendas that focus their paradigms. Politicians and government economists want us to believe that the trillions we are spending is a brilliant idea. Those who predict doom-and-gloom profit handsomely as stoking fear sells their books and newsletters. Emotionally it is easy for us to assume the short-term upswing in the stock market means the recession is over, or seeing the market drop 25% in a couple of months means we are headed to Armageddon.
The final outcome of this historical financial crisis will likely to take 3-7 years to work out, and I doubt that we will bottom out before 2011 or 2012. Political agendas of both parties were a factor in creating this circumstance. Many regulations now scorned were once endorsed by both parties, e.g. encouraging mortgages to provide home ownership for all Americans. This seemed like a good idea at a time but most see that financial regulations need to be adapted to suit a society where many people are very naïve in financial matters.
People on both sides of the aisle should be concerned and active in this conversation. Our political process depends on our input. But don’t let it ruin your life. Don’t let the extremists in the political arena and their counterparts in the financial media lead you to take precipitous moves with your investments.
Functional Asset Allocation takes your personal situation as the primary driver in allocating your investments. While changes will need to be made this year, we want you to be able to survive any economic trend. Our job is to make sure you can sleep at night.
How will this recession play out? I like to ask people that question (although many of them think I should know). I have noticed a strong correlation between a person’s economic outlook and their political leanings. The extremists on both sides focus on certain factors in the global meltdown to support their point of view. I’d like to examine the extremes on both sides and explain why both an extreme positive or negative outlook is at best a very remote possibility.
The Best Case: The Stimulus plan works as designed world-wide and the economy bottoms out at the end of this year. The rebound is very rapid so that the stock market is back up to 13,000 by the end of 2010 and unemployment drops to 5% and we all sing “Happy Days Are Here Again!” The government devises regulations for banks and oil producers with congressional oversight to control their profits and pricing. Taxes are raised on businesses, investors, and high income earners to pay for energy, education, and health care services while lowering the deficit with the increased revenue. Increased government spending causes inflation which threatens to get out of control.
The Worst Case: The worldwide economy reels toward collapse with the US government selling bonds to provide money to support an ever-expanding list of government-provided entitlements, bailouts, and subsidies. More pressure is applied to other countries to follow our lead, resulting in rising stagflation worldwide and hyper-inflation in some countries threatens to spread globally.
Gross Domestic Production world-wide drops precipitously. Higher tax rates to target the most productive sectors of the economy result in less total government revenue as sales and incomes drop. Small businesses close, or start operating under-ground. Unemployment rises and pushes the world into a global depression. Protests and crime increase as populations become more impoverished. War looms.
The Truth: Neither of the two above scenarios are going to play out to the conclusion. This economic cycle will end and we will recover at some point. Stimulus programs may do more harm than good, but we are not going to become a socialist country. The dollar will not collapse and putting all your wealth in gold or another currency to avoid being wiped out is nonsensical..
There are simply too many economic factors at work to be able to determine the outcome. Most changes in a free market are self-correcting, e.g. as the dollar weakens, more foreigners want to buy US goods, services and real estate, which ultimately strengthen our economy and the dollar rises again. Supply and demand result in short-term price swings as markets seek balance by testing the extremes. Lower beef prices mean more people will start eating beef, and then ranchers will grow more steers. The outlook is further clouded by completely unexpected events such as a California earthquake, or a war in the Middle East that shuts down 50% of the world’s oil supply.
Most readers of this blog have already been impacted by this recession, and those who haven’t yet are likely to be in the next year. The worst reaction, however, is to bank on an extreme scenario. It is just as foolish to sell everything you own to buy gold because some writer ‘proves’ that hyperinflation is inevitable. It is folly to put all your assets into real estate because it’s so cheap now, and you believe that the big turnaround has already begun. Home prices are still dropping, and I remember the wisdom of my father: “Son, never try to catch a falling knife!”
The proponents of both extremes have personal agendas that focus their paradigms. Politicians and government economists want us to believe that the trillions we are spending is a brilliant idea. Those who predict doom-and-gloom profit handsomely as stoking fear sells their books and newsletters. Emotionally it is easy for us to assume the short-term upswing in the stock market means the recession is over, or seeing the market drop 25% in a couple of months means we are headed to Armageddon.
The final outcome of this historical financial crisis will likely to take 3-7 years to work out, and I doubt that we will bottom out before 2011 or 2012. Political agendas of both parties were a factor in creating this circumstance. Many regulations now scorned were once endorsed by both parties, e.g. encouraging mortgages to provide home ownership for all Americans. This seemed like a good idea at a time but most see that financial regulations need to be adapted to suit a society where many people are very naïve in financial matters.
People on both sides of the aisle should be concerned and active in this conversation. Our political process depends on our input. But don’t let it ruin your life. Don’t let the extremists in the political arena and their counterparts in the financial media lead you to take precipitous moves with your investments.
Functional Asset Allocation takes your personal situation as the primary driver in allocating your investments. While changes will need to be made this year, we want you to be able to survive any economic trend. Our job is to make sure you can sleep at night.
Friday, March 13, 2009
Have the Rules Changed?
Bert Whitehead, M.B.A., J.D. © 2009
We are experiencing the worst economic crisis since the Great Depression, and we are likely to see further erosion. It’s a perfect storm brought on simultaneously by a financial crash, a real estate crash, and an economic crash. Investors who have always ‘played by the rules’ by diversifying their portfolios are confronted by the reality that all asset classes are collapsing, except for long-term Treasuries and perhaps gold. Small businesses are closing, real estate across the nation has tanked, and even the safety of banks and insurance companies are questionable.
So have the rules changed? Many investment strategies which have long been considered sacred don’t work anymore. The basic principles which we use in Functional Asset Allocation, however, are sound. That means that investment portfolios should be based on ‘endogenous’ factors that reflect the client’s individual circumstances.
Most investment strategies have been based on Modern Portfolio Theory. This assumes that the correlations of investment performance should be the dominant consideration in constructing and managing a portfolio. Investment managers all promised they could ‘time the market’ to take advantage of the next asset class which would out-perform the market.
Those strategies are always based on ‘exogenous’ factors such as interest rates, historical performance of stocks, oil prices, etc. Long-term US Treasuries have never been considered as the core of a portfolio, because brokers don’t make any money on Treasury bonds unless they are constantly being traded.
For our clients, we are re-evaluating the appropriate investment risk exposure based on each individual situation. The ‘invisible hand of the market’ has radically rebalanced our portfolios so that most are now heavily weighted in bonds and cash vs. stocks. We do not slavishly sell out bond ladders to boost the client’s exposure to stocks.
The current economic cycle has magnified the risks clients are exposed to. Job security is questionable, real estate values have plummeted, and businesses across the board are faltering. In reviewing clients’ portfolios we take we consider three primary risk factors:
1) How much risk does a client need to take to achieve financial independence, i.e. how much is enough? If you already have enough to survive this financial cycle, we will recommend that you take less risk in your portfolio than previously.
2) How much risk are you already taking? If you have your own business, or are subject to being laid off, or are concerned about becoming disabled, it is appropriate certainly to take less risk in your portfolio since these risks are greater now than last year.
3) How much risk is appropriate for your situation? If you have dependents, kids to send to college, too much leveraged real estate, etc. your portfolio should be more conservative. If you are single with a good job and in good health, you may want to be more aggressive. Note that this has nothing to do with ‘risk tolerance’ which is an unreliable and irrelevant factor when balancing a portfolio.
We generally try not to reduce clients’ exposure to market risk by selling off stocks and equity mutual funds despite market drops. This cycle will pass eventually and maintaining a position in the market is critical to rebuilding your portfolio. Clearly younger clients have a once-in-a-lifetime opportunity to achieve financial independence by dollar cost averaging in the market now through their 401-K’s and other pension options.
When extra cash is available, we want to reinforce or add to clients’ bond ladders where appropriate. And in today’s markets, a heavy cash position is often appropriate. We are also cognizant that the government stimulus, which is being funded with a flood of Treasury debt, will likely cause serious inflation down the road.
The problem is that the current deflationary cycle may last 1-2 more years, or possibly 5-10 more years. Rather than selling Treasuries, we are positioning clients for inflation by increasing their cash cushion (which will earn higher interest in inflationary cycles) and urging clients to remortgage their homes with 30 year mortgages if they can do so for a rate that is 1.0% or more less than their current rate.
We are monitoring the investments which are held by our clients, and may make short-term suggestions during your tax appointment or by email. After tax season we will be reviewing your portfolio with you in depth to identify the appropriate amount of risk we suggest in your circumstances and the corresponding rebalancing required in your portfolio. The market is so volatile and unstable currently that we are avoiding unnecessary market moves.
Occasional market rebounds, as we recently have seen, don’t indicate that this economy has turned around. A single swallow doesn’t mean spring is here. While most polls indicate that the general public is optimistic about the federal government stimulus and other bold intervention, the overwhelming consensus of the business and financial communities is very negative. Market reaction has exacerbated fear and panic among investors.
The concern is that government reaction to the crisis is not focused on the central problems: financial institutions and housing. It is the uncertainty whether massive splintered federal spending, knee-jerk regulation, and laws targeted to special interests is doing more long-term harm with little to show in short term gain. This recession is world wide with most countries even worse than we are, and international markets are now increasingly concerned about the stability of Treasury debt.
As a result we really don’t know which way the market and the economy is headed. Many government economists are confident that the recovery will begin this year, though more stimulus spending may be needed. Wall Street is generally more pessimistic, expecting this downhill slide to last 5 years or more. That would mean even lower interest rates, further stock market drops, and real estate stagnation. It is not prudent to guess at this point which way the economy will go over the next 3-6 months and make major shift in portfolios.
No matter what happens, we want to take whatever steps are needed to protect you financially. The rules of Functional Asset Allocation haven’t changed, but it is likely that your world is changing and we will make sure your portfolio is adjusted accordingly.
We are experiencing the worst economic crisis since the Great Depression, and we are likely to see further erosion. It’s a perfect storm brought on simultaneously by a financial crash, a real estate crash, and an economic crash. Investors who have always ‘played by the rules’ by diversifying their portfolios are confronted by the reality that all asset classes are collapsing, except for long-term Treasuries and perhaps gold. Small businesses are closing, real estate across the nation has tanked, and even the safety of banks and insurance companies are questionable.
So have the rules changed? Many investment strategies which have long been considered sacred don’t work anymore. The basic principles which we use in Functional Asset Allocation, however, are sound. That means that investment portfolios should be based on ‘endogenous’ factors that reflect the client’s individual circumstances.
Most investment strategies have been based on Modern Portfolio Theory. This assumes that the correlations of investment performance should be the dominant consideration in constructing and managing a portfolio. Investment managers all promised they could ‘time the market’ to take advantage of the next asset class which would out-perform the market.
Those strategies are always based on ‘exogenous’ factors such as interest rates, historical performance of stocks, oil prices, etc. Long-term US Treasuries have never been considered as the core of a portfolio, because brokers don’t make any money on Treasury bonds unless they are constantly being traded.
For our clients, we are re-evaluating the appropriate investment risk exposure based on each individual situation. The ‘invisible hand of the market’ has radically rebalanced our portfolios so that most are now heavily weighted in bonds and cash vs. stocks. We do not slavishly sell out bond ladders to boost the client’s exposure to stocks.
The current economic cycle has magnified the risks clients are exposed to. Job security is questionable, real estate values have plummeted, and businesses across the board are faltering. In reviewing clients’ portfolios we take we consider three primary risk factors:
1) How much risk does a client need to take to achieve financial independence, i.e. how much is enough? If you already have enough to survive this financial cycle, we will recommend that you take less risk in your portfolio than previously.
2) How much risk are you already taking? If you have your own business, or are subject to being laid off, or are concerned about becoming disabled, it is appropriate certainly to take less risk in your portfolio since these risks are greater now than last year.
3) How much risk is appropriate for your situation? If you have dependents, kids to send to college, too much leveraged real estate, etc. your portfolio should be more conservative. If you are single with a good job and in good health, you may want to be more aggressive. Note that this has nothing to do with ‘risk tolerance’ which is an unreliable and irrelevant factor when balancing a portfolio.
We generally try not to reduce clients’ exposure to market risk by selling off stocks and equity mutual funds despite market drops. This cycle will pass eventually and maintaining a position in the market is critical to rebuilding your portfolio. Clearly younger clients have a once-in-a-lifetime opportunity to achieve financial independence by dollar cost averaging in the market now through their 401-K’s and other pension options.
When extra cash is available, we want to reinforce or add to clients’ bond ladders where appropriate. And in today’s markets, a heavy cash position is often appropriate. We are also cognizant that the government stimulus, which is being funded with a flood of Treasury debt, will likely cause serious inflation down the road.
The problem is that the current deflationary cycle may last 1-2 more years, or possibly 5-10 more years. Rather than selling Treasuries, we are positioning clients for inflation by increasing their cash cushion (which will earn higher interest in inflationary cycles) and urging clients to remortgage their homes with 30 year mortgages if they can do so for a rate that is 1.0% or more less than their current rate.
We are monitoring the investments which are held by our clients, and may make short-term suggestions during your tax appointment or by email. After tax season we will be reviewing your portfolio with you in depth to identify the appropriate amount of risk we suggest in your circumstances and the corresponding rebalancing required in your portfolio. The market is so volatile and unstable currently that we are avoiding unnecessary market moves.
Occasional market rebounds, as we recently have seen, don’t indicate that this economy has turned around. A single swallow doesn’t mean spring is here. While most polls indicate that the general public is optimistic about the federal government stimulus and other bold intervention, the overwhelming consensus of the business and financial communities is very negative. Market reaction has exacerbated fear and panic among investors.
The concern is that government reaction to the crisis is not focused on the central problems: financial institutions and housing. It is the uncertainty whether massive splintered federal spending, knee-jerk regulation, and laws targeted to special interests is doing more long-term harm with little to show in short term gain. This recession is world wide with most countries even worse than we are, and international markets are now increasingly concerned about the stability of Treasury debt.
As a result we really don’t know which way the market and the economy is headed. Many government economists are confident that the recovery will begin this year, though more stimulus spending may be needed. Wall Street is generally more pessimistic, expecting this downhill slide to last 5 years or more. That would mean even lower interest rates, further stock market drops, and real estate stagnation. It is not prudent to guess at this point which way the economy will go over the next 3-6 months and make major shift in portfolios.
No matter what happens, we want to take whatever steps are needed to protect you financially. The rules of Functional Asset Allocation haven’t changed, but it is likely that your world is changing and we will make sure your portfolio is adjusted accordingly.
Friday, February 27, 2009
Five Stupid Things Smart People Are Doing With Their Investments
Five Stupid Things Smart People Are Doing With Their Investments
Bert Whitehead, M.B.A., J.D. © 2009
The collapse of the financial markets has sparked terror for many investors. It’s hard to watch your regular 401-k contributions invested in solid mutual funds, and then vanish each month. If you are laid off, the fear of depleting your savings is gut-wrenching. If you are retired, unless you have a bond ladder, you may be thinking of going back to work. If you were planning to retire soon you may be postponing those plans. None of these options are very desirable.
People being people, our financial decisions are often based on how we feel rather than a rational process. Often these times lead people to take drastic action. They hope to reclaim all of the money they have lost in one brilliant financial move. The problem is that such approaches to investing are blatantly stupid, and I have seen the wreckage caused in the past when clients decided to ‘go for broke.’ This is the Gamblers Last Gambit: one last grasp to win all the losses back in one grand stroke. Here are five ways I’ve seen this happen with investors:
1. In 2002, a client who had lost a sizable portion of his money on the dot-com bust, sold every stock he had left and put it in cash. Vowing never to invest in the stock market again, he stayed on the sideline in 2003, when the market increased 30%, and missed the chance to have his portfolio recover.
2. Just recently a woman left her stockbroker who had her over-exposed to financial stocks which lost 80% of their value. Then she took the rest of her money and decided to buy puts and calls herself to make up her losses. In less than 6 months, she’s lost most of what she had left.
3. Another couple last year decided to sell their Treasury bonds last year, because they had appreciated so much. They planned to hold on to the cash and buy the bonds back when interest rates went back up. Meanwhile they have been earning less than 1%, and interest rates continue to drop and they can’t afford to buy their bonds back.
4. Then there’s the fellow who withdrew all his IRA savings and bought lottery tickets so he could retire early. (OK, he had brain cancer, so that’s an excuse).
5. Finally, there was a very smart financial advisor I knew in the 1990’s. He became a fan of the doom’s-day prophet of the time, and convinced his clients to sell all their assets and buy gold. He also did this with all his investments. (Not a good move in the ‘90’s!)
Now financial gurus are touting gold, or risky investment strategies, playing on investor’s fears to induce them to pay them for their secrets. Every stockbroker wants people to sell their Treasuries and let them invest the money = “Give me your money and I’ll make you rich!”.
Your situation is unique. We understand the broad context of your life situation and tailor your investments accordingly. It is futile to try to ‘hit a home run’ in this economic environment.
It takes patience. That’s why stocks are called long-term investments. For younger clients this is the best opportunity for you to guarantee your retirement. With stocks so low, continuing to dollar-cost-average now is a once in a life-time chance. For retirees with bond ladders, you have a 15-20 year investment horizon if you just wait for the economy to rebound. Taking sudden action now is folly.
The best thing to do is to stop listening to financial news on TV, reading the ‘ain’t it awful headlines’ and always looking for a guru to tell you the key to financial success. If anyone knew that, which there isn’t, they wouldn’t tell you because if everyone did it, their strategy wouldn’t work anymore. Face it: they make money selling newsletters to incite greed and fear. If you want to get rich quick, start your own newsletter!
“Fools rush in where Angels fear to tread.”
Bert Whitehead, M.B.A., J.D. © 2009
The collapse of the financial markets has sparked terror for many investors. It’s hard to watch your regular 401-k contributions invested in solid mutual funds, and then vanish each month. If you are laid off, the fear of depleting your savings is gut-wrenching. If you are retired, unless you have a bond ladder, you may be thinking of going back to work. If you were planning to retire soon you may be postponing those plans. None of these options are very desirable.
People being people, our financial decisions are often based on how we feel rather than a rational process. Often these times lead people to take drastic action. They hope to reclaim all of the money they have lost in one brilliant financial move. The problem is that such approaches to investing are blatantly stupid, and I have seen the wreckage caused in the past when clients decided to ‘go for broke.’ This is the Gamblers Last Gambit: one last grasp to win all the losses back in one grand stroke. Here are five ways I’ve seen this happen with investors:
1. In 2002, a client who had lost a sizable portion of his money on the dot-com bust, sold every stock he had left and put it in cash. Vowing never to invest in the stock market again, he stayed on the sideline in 2003, when the market increased 30%, and missed the chance to have his portfolio recover.
2. Just recently a woman left her stockbroker who had her over-exposed to financial stocks which lost 80% of their value. Then she took the rest of her money and decided to buy puts and calls herself to make up her losses. In less than 6 months, she’s lost most of what she had left.
3. Another couple last year decided to sell their Treasury bonds last year, because they had appreciated so much. They planned to hold on to the cash and buy the bonds back when interest rates went back up. Meanwhile they have been earning less than 1%, and interest rates continue to drop and they can’t afford to buy their bonds back.
4. Then there’s the fellow who withdrew all his IRA savings and bought lottery tickets so he could retire early. (OK, he had brain cancer, so that’s an excuse).
5. Finally, there was a very smart financial advisor I knew in the 1990’s. He became a fan of the doom’s-day prophet of the time, and convinced his clients to sell all their assets and buy gold. He also did this with all his investments. (Not a good move in the ‘90’s!)
Now financial gurus are touting gold, or risky investment strategies, playing on investor’s fears to induce them to pay them for their secrets. Every stockbroker wants people to sell their Treasuries and let them invest the money = “Give me your money and I’ll make you rich!”.
Your situation is unique. We understand the broad context of your life situation and tailor your investments accordingly. It is futile to try to ‘hit a home run’ in this economic environment.
It takes patience. That’s why stocks are called long-term investments. For younger clients this is the best opportunity for you to guarantee your retirement. With stocks so low, continuing to dollar-cost-average now is a once in a life-time chance. For retirees with bond ladders, you have a 15-20 year investment horizon if you just wait for the economy to rebound. Taking sudden action now is folly.
The best thing to do is to stop listening to financial news on TV, reading the ‘ain’t it awful headlines’ and always looking for a guru to tell you the key to financial success. If anyone knew that, which there isn’t, they wouldn’t tell you because if everyone did it, their strategy wouldn’t work anymore. Face it: they make money selling newsletters to incite greed and fear. If you want to get rich quick, start your own newsletter!
“Fools rush in where Angels fear to tread.”
Tuesday, February 17, 2009
Danger: Inflation/Stagflation Ahead?
Danger: Inflation/Stagflation Ahead?
© 2009 Bert Whitehead, M.B.A., J.D.
Now that the ‘Stimulus Bill’ is in place, how is the government going to pay for all of these new programs and tax cuts? Anticipating the need for additional funds, the Treasury has already begun to issue more Treasury securities* and has scheduled more auctions. So if the government piles on more debt, does this increase in the money supply mean we are on the brink of hyper-inflation, or a return of the ‘stagflation’ of the 1970’s?
Not necessarily: if our nation’s productivity increases in tandem with the money supply, inflation is not likely. In the ‘70’s we had declining productivity combined with entrenched inflation, and the result of high unemployment and high inflation was dubbed “stagflation.” Normally in the beginning of a recession, there is an increase in productivity since production does not drop as fast as employment. For example, in the last quarter of 2008 productivity rose 3.2% in the nonfarm business sector, as hours fell faster than output.
As new employment is stimulated, the plan is to be able to increase productivity simultaneously. There is some concern that, since the jobs initially funded will all be in the public sector, productivity will fall (since productivity only measures business, non-farm business and manufacturing output). Keynesian economics, which is the theory this strategy is based on, projects that the stimulus to the public sector and government spending will ignite private investment and job creation. There is broad disagreement as to whether this worked for FDR in the 1930’s, since the depression didn’t actually end until we entered WW II.
If it doesn’t work, we may well go into a prolonged recession, like the ‘lost decade’ discussed in my last blog. If it does well, the business sector will hopefully recover in a couple of years and start creating new jobs and we will again enjoy prosperity. But government does not create new jobs. If the jobs which are funded are to continue, the government has to keep funding them.
So the danger of inflation will depend on whether we end up becoming dependent on deficit spending. If our economy is worse in 2-3 years, there will be many who will argue that we didn’t spend enough, and insist on increasing government subsidies. This would be aggravated if businesses can’t get back on their feet and unemployment increases. This could produce very painful stagflation.
We don’t know if we face inflation/stagnation, or recession and a dead decade, or reignited prosperity. We don’t do market timing; we seek balance. Our clients are protected by long-term Treasuries if deflation continues. We keep our clients’ positions in equities so when the economy does recover, they will participate in prosperity. So now we are reviewing our client’s portfolios to make sure they will withstand inflation.
Gold and unhedged international mutual funds in the past were bulwarks against inflation. Now gold can be easily traded through ETF’s and so it has become very speculative, which would not be dependable in inflation. Being diversified with international holdings may not be effective since inflation would likely be worldwide.
Having a fixed rate mortgage on your residence is a very effective offset to inflation. Interest rates parallel inflation, so even if you parked the mortgage proceeds in a money market fund, high inflation would raise money market rates. Plus there is an advantage in paying off your mortgage with cheaper dollars.
In recent years, the US Treasury has started issuing ‘TIPS’ (Treasury Inflation Protected Securities). The interest rate on these varies based on the inflation rate. These are not a good replacement for your bond ladder, since they don’t offer protection against deflation. A strong strategy to protect against inflation, if you don’t have a mortgage on your house, is to take out a $300,000 mortgage and use the proceeds to buy TIPS.
Finally we recommend that clients keep an extra cash cushion in this volatile economy. While short term interest rates are low now, cash does provide insurance against higher inflation since interest rates would increase in lock-step. Clients with uncertain job prospects or high expenses looming should maintain additional liquidity. Cash also enables clients to be nimble in these uncertain times and handle unforeseen emergencies without decimating their portfolios.
If you would like to discuss these issues more to see how your portfolio would be affected, feel free to call your Cambridge Advisor for an appointment.
*Treasury Securities include:
Treasury Bills = 1 month – 2 years
Treasury Notes =2 years – 10 years
Treasury Bonds = 10 years – 30 years
This is the only distinction between Treasury bills, notes, and bonds.
© 2009 Bert Whitehead, M.B.A., J.D.
Now that the ‘Stimulus Bill’ is in place, how is the government going to pay for all of these new programs and tax cuts? Anticipating the need for additional funds, the Treasury has already begun to issue more Treasury securities* and has scheduled more auctions. So if the government piles on more debt, does this increase in the money supply mean we are on the brink of hyper-inflation, or a return of the ‘stagflation’ of the 1970’s?
Not necessarily: if our nation’s productivity increases in tandem with the money supply, inflation is not likely. In the ‘70’s we had declining productivity combined with entrenched inflation, and the result of high unemployment and high inflation was dubbed “stagflation.” Normally in the beginning of a recession, there is an increase in productivity since production does not drop as fast as employment. For example, in the last quarter of 2008 productivity rose 3.2% in the nonfarm business sector, as hours fell faster than output.
As new employment is stimulated, the plan is to be able to increase productivity simultaneously. There is some concern that, since the jobs initially funded will all be in the public sector, productivity will fall (since productivity only measures business, non-farm business and manufacturing output). Keynesian economics, which is the theory this strategy is based on, projects that the stimulus to the public sector and government spending will ignite private investment and job creation. There is broad disagreement as to whether this worked for FDR in the 1930’s, since the depression didn’t actually end until we entered WW II.
If it doesn’t work, we may well go into a prolonged recession, like the ‘lost decade’ discussed in my last blog. If it does well, the business sector will hopefully recover in a couple of years and start creating new jobs and we will again enjoy prosperity. But government does not create new jobs. If the jobs which are funded are to continue, the government has to keep funding them.
So the danger of inflation will depend on whether we end up becoming dependent on deficit spending. If our economy is worse in 2-3 years, there will be many who will argue that we didn’t spend enough, and insist on increasing government subsidies. This would be aggravated if businesses can’t get back on their feet and unemployment increases. This could produce very painful stagflation.
We don’t know if we face inflation/stagnation, or recession and a dead decade, or reignited prosperity. We don’t do market timing; we seek balance. Our clients are protected by long-term Treasuries if deflation continues. We keep our clients’ positions in equities so when the economy does recover, they will participate in prosperity. So now we are reviewing our client’s portfolios to make sure they will withstand inflation.
Gold and unhedged international mutual funds in the past were bulwarks against inflation. Now gold can be easily traded through ETF’s and so it has become very speculative, which would not be dependable in inflation. Being diversified with international holdings may not be effective since inflation would likely be worldwide.
Having a fixed rate mortgage on your residence is a very effective offset to inflation. Interest rates parallel inflation, so even if you parked the mortgage proceeds in a money market fund, high inflation would raise money market rates. Plus there is an advantage in paying off your mortgage with cheaper dollars.
In recent years, the US Treasury has started issuing ‘TIPS’ (Treasury Inflation Protected Securities). The interest rate on these varies based on the inflation rate. These are not a good replacement for your bond ladder, since they don’t offer protection against deflation. A strong strategy to protect against inflation, if you don’t have a mortgage on your house, is to take out a $300,000 mortgage and use the proceeds to buy TIPS.
Finally we recommend that clients keep an extra cash cushion in this volatile economy. While short term interest rates are low now, cash does provide insurance against higher inflation since interest rates would increase in lock-step. Clients with uncertain job prospects or high expenses looming should maintain additional liquidity. Cash also enables clients to be nimble in these uncertain times and handle unforeseen emergencies without decimating their portfolios.
If you would like to discuss these issues more to see how your portfolio would be affected, feel free to call your Cambridge Advisor for an appointment.
*Treasury Securities include:
Treasury Bills = 1 month – 2 years
Treasury Notes =2 years – 10 years
Treasury Bonds = 10 years – 30 years
This is the only distinction between Treasury bills, notes, and bonds.
Monday, February 2, 2009
Past Performance is No Guarantee
Past Performance Is No Guarantee…
by Bert Whitehead, M.B.A., J.D. © 2009
In the past 75 years (1934-2008) the S&P stock index has suffered total return losses of more than 20% in four different calendar years, the most recent was last year’s 37.0% decline. In the year after the three previous 20%+ declines, the index gained an average of 32%.
The danger of liquidating stocks now is when the market does turn around it will likely be very sudden. Investors who seek an all-cash haven will miss out on the growth
Most clients have bond ladders with US Stripped Treasuries that have appreciated significantly. It is tempting to sell the treasuries to reap the capital gain now, and plan on buying them back when interest rates go back up.
We don’t recommend selling as the bond ladder gives you certainty. If this recession comes to an end soon, increases in stock values will allow your portfolio to correct itself. If the recession persists, however, you will not be able to replace your ladder for the amount you sell it for now.
There is a 20-30% chance that we may be facing a ‘Dead Decade.’ This financial phenomenon is rare, but it does occur. Japan went through a ‘Dead Decade’ in the 1990’s. The Nikkei stock market dropped from 37,000 to 10,000 and never closed above 15000 for 10 years. At the same time, interest rates dropped in Japan to 1.0-2.0% even for long term government bonds.
We don’t try to time the market, and are not predicting that a ‘Dead Decade’ is in store for the US. However, we do plan for a prolonged economic squeeze, which may well suppress interest rates even below current levels. This is the most dangerous possibility we may face.
While the changes we are experiencing are exogenous, many clients are feeling the effects endogenously. We are stressing to keep high liquidity during this post-election turmoil, and not selling long-term investment assets. Each individual’s situation is different, so your investment portfolio must take into account the risks which you may face.
It is easy to believe that the past will be repeated, but when it comes to the market, history is not a reliable predictor of future performance.
by Bert Whitehead, M.B.A., J.D. © 2009
In the past 75 years (1934-2008) the S&P stock index has suffered total return losses of more than 20% in four different calendar years, the most recent was last year’s 37.0% decline. In the year after the three previous 20%+ declines, the index gained an average of 32%.
The danger of liquidating stocks now is when the market does turn around it will likely be very sudden. Investors who seek an all-cash haven will miss out on the growth
Most clients have bond ladders with US Stripped Treasuries that have appreciated significantly. It is tempting to sell the treasuries to reap the capital gain now, and plan on buying them back when interest rates go back up.
We don’t recommend selling as the bond ladder gives you certainty. If this recession comes to an end soon, increases in stock values will allow your portfolio to correct itself. If the recession persists, however, you will not be able to replace your ladder for the amount you sell it for now.
There is a 20-30% chance that we may be facing a ‘Dead Decade.’ This financial phenomenon is rare, but it does occur. Japan went through a ‘Dead Decade’ in the 1990’s. The Nikkei stock market dropped from 37,000 to 10,000 and never closed above 15000 for 10 years. At the same time, interest rates dropped in Japan to 1.0-2.0% even for long term government bonds.
We don’t try to time the market, and are not predicting that a ‘Dead Decade’ is in store for the US. However, we do plan for a prolonged economic squeeze, which may well suppress interest rates even below current levels. This is the most dangerous possibility we may face.
While the changes we are experiencing are exogenous, many clients are feeling the effects endogenously. We are stressing to keep high liquidity during this post-election turmoil, and not selling long-term investment assets. Each individual’s situation is different, so your investment portfolio must take into account the risks which you may face.
It is easy to believe that the past will be repeated, but when it comes to the market, history is not a reliable predictor of future performance.
Sunday, November 30, 2008
The Root of the Problem
The Root of the Problem
Bert Whitehead, M.B.A., J.D.
© 2008
Five ‘up-days on the Dow’ gives us a chance to catch our breath and ponder: What is the root of the problem? Three considerations come to mind.
1) Mortgages made too easy to provide affordable housing has resulted in too many families having to go back to renting. The root problem in real estate is too many houses: population shifts and housing speculation has resulted in having more houses than we have people to live in them. The housing glut means that real estate will be depressed for at least a couple more years.
From an endogenous standpoint, that means if you have a vacant house, cut the price until you can sell it. The root of the continuing housing problem is that too many people don’t price their vacant houses realistically. The price has to go down to the point that it makes financial sense for investors to buy them and rent them out.
2) The root problem with the stock market is that investors have reacted with sheer panic to the liquidity problem (caused by too many non-performing mortgages). The primary valuation indicators show that the worldwide stock market is underpriced. Governments are acting in concert to add liquidity, which is a very complex undertaking. Mistakes have been made with the bailouts, but eventually they will get it right. FDR didn’t get it right to start with when he battled the Depression, but he did engender confidence in people that the problem was being addressed. Confidence in our leadership will suffocate rampant panic.
Expect the stock market to rebound before real estate. It’s not a given that the market increases over the past 5 trading days signal the end of the bear market. The market will turnaround before the economy starts to recover, and when the market does turn around it is likely to increase very rapidly. That’s why we don’t want you to panic and sell off your portfolio, especially now.
3) Being ‘rich’ means having enough money to buy and do whatever you want. Being ‘wealthy’ means being rich enough to take time to enjoy life. It doesn’t take a lot of money to be rich, and it is too easy to focus too much on ‘rich’ rather than ‘wealth.’ The current problems in our economy remind us how transient our stacks of money are, whereas wealth is within our control. The root problem of feeling poor is our own mindset.
Thanksgiving is a wonderful time in our culture to reflect we are indeed wealthy, even if we are not as rich as we could be.
Bert Whitehead, M.B.A., J.D.
© 2008
Five ‘up-days on the Dow’ gives us a chance to catch our breath and ponder: What is the root of the problem? Three considerations come to mind.
1) Mortgages made too easy to provide affordable housing has resulted in too many families having to go back to renting. The root problem in real estate is too many houses: population shifts and housing speculation has resulted in having more houses than we have people to live in them. The housing glut means that real estate will be depressed for at least a couple more years.
From an endogenous standpoint, that means if you have a vacant house, cut the price until you can sell it. The root of the continuing housing problem is that too many people don’t price their vacant houses realistically. The price has to go down to the point that it makes financial sense for investors to buy them and rent them out.
2) The root problem with the stock market is that investors have reacted with sheer panic to the liquidity problem (caused by too many non-performing mortgages). The primary valuation indicators show that the worldwide stock market is underpriced. Governments are acting in concert to add liquidity, which is a very complex undertaking. Mistakes have been made with the bailouts, but eventually they will get it right. FDR didn’t get it right to start with when he battled the Depression, but he did engender confidence in people that the problem was being addressed. Confidence in our leadership will suffocate rampant panic.
Expect the stock market to rebound before real estate. It’s not a given that the market increases over the past 5 trading days signal the end of the bear market. The market will turnaround before the economy starts to recover, and when the market does turn around it is likely to increase very rapidly. That’s why we don’t want you to panic and sell off your portfolio, especially now.
3) Being ‘rich’ means having enough money to buy and do whatever you want. Being ‘wealthy’ means being rich enough to take time to enjoy life. It doesn’t take a lot of money to be rich, and it is too easy to focus too much on ‘rich’ rather than ‘wealth.’ The current problems in our economy remind us how transient our stacks of money are, whereas wealth is within our control. The root problem of feeling poor is our own mindset.
Thanksgiving is a wonderful time in our culture to reflect we are indeed wealthy, even if we are not as rich as we could be.
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