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.
Friday, March 13, 2009
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.
Monday, October 27, 2008
How Bad Can It Get?
It’s time to get our heads out from under the covers and face our worst fears. The financial crisis is world-wide, and the U.S. is actually better off than most countries. Iceland is bankrupt, and others (including Russia) are teetering. What happens when a crisis turns into a complete collapse?
Keep in mind that the worst possible outcomes are short-term. We’ll take a look at those and then look at the reality of the long-term.
Short-term Possibilities:
Scenario #1: Complete Financial Collapse. Likelihood = 1% - 2%. This could rival the Great Depression scenes we see in old movies with bread lines, tent towns of homeless, etc. You’re not able to use your credit cards, or write checks. In the worst case, where faith in US dollar evaporates, bartering or using gold becomes the basis of commerce.
This extreme outcome could be produced in our current economy if one or two extremely destructive exogenous events occur in the next year or so. These traumatic events could be anything from a huge California earthquake, Al Qaeda usurping power in Saudi Arabia and strangling the world’s oil supply, or severe weather changes brought on by global warming, etc.
We have suggested that clients who are genuinely concerned about this worst-case scenario keep 1-2% of their portfolio in gold bullion.
Scenario #2: World-wide Deflation. Likelihood = 5-20%. Countries try to protect their economies using tariffs, which sets off retaliation in other countries so global commerce dries up. Shortages become a way of life. Widespread deprivation kindles violence, terrorism escalates, and a large scale war may loom.
Even in this case, the dollar would likely be the world’s safe haven. Decreasing prices enable those who have cash or U.S. Treasury bonds to survive and prosper.
Scenario #3: Recession Reaction. Likelihood – 15-35%. Panic sets off contraction in consumer spending which cascades through the economy. Classic recession response, including lay-offs, unemployment of 10-15% in US, higher in other countries. The Euro may be destabilized by conflicts in monetary policies of member nations. Cutbacks in inventories closes factories; bankruptcies increase. Portfolio Panic Reaction leads many people to take foolish risks.
We work closely with clients to manage their endogenous risks, rebalance portfolios accordingly, make sure that adequate liquidity is maintained.
Scenario #4: Volatility Eruption. Likelihood = 25-40%. We are likely experiencing this phase now. Market prices in securities, commodities, housing, etc. take huge swings in waves of panic trading. Investors retreat to the sidelines, so trading volumes vacillate. This is how the market finds price balance, by testing the extremes. This could be a relatively short phase followed by onset of recession which could be severe, or gradually recover as markets begin to bounce back.
This is most difficult time for investors. In today’s economies this scenario usually stirs government intervention in the markets. This brings the danger that the money supply is increased faster than productivity gains which can trigger spiraling inflation. Having a long-term fixed rate mortgage is the best protection against inflation. Survival in this phase requires clients to turn off the TV.
Scenario #5: Bounce Back. Likelihood = 15-35%. If governments are successful in shoring up confidence in their economies, and adequate liquidity is available in capital markets, stable commerce will again emerge. Housing prices will drop to the point where entrepreneurs can buy up excess inventory and rent out homes with a positive cash flow. New business formations provide most new employment opportunities.
The stock market is likely to start rebounding a year or so before this phase kicks in. Clients guided by Functional Asset Allocation, which we preach, will prosper in this stage since they will not have sold off their stock holdings. Those who have continued dollar-cost-averaging, (e.g. through their 401-k’s, etc.) will enjoy rapid accumulation in their portfolios.
Long-term Outlook. Likelihood – 98-99%. As this downturn is relatively severe, it may take another 2-3 years to substantially recover. Then we will enjoy approximately 5.5 years (on average) of prosperity, which we will soon take for granted. On the next downturn, we will be again surprised. We will go through though another down-cycle as we have for the past century. Again we will think that ‘it is different this time.’ A year or so into that downturn we will again anguish about “How Bad Can It Get?” Then I will send out this blog again, as I did seven years ago in Nov. 2001…
Sleep well tonight! Bert
© Bert Whitehead, M.B.A., J.D. 2008
Keep in mind that the worst possible outcomes are short-term. We’ll take a look at those and then look at the reality of the long-term.
Short-term Possibilities:
Scenario #1: Complete Financial Collapse. Likelihood = 1% - 2%. This could rival the Great Depression scenes we see in old movies with bread lines, tent towns of homeless, etc. You’re not able to use your credit cards, or write checks. In the worst case, where faith in US dollar evaporates, bartering or using gold becomes the basis of commerce.
This extreme outcome could be produced in our current economy if one or two extremely destructive exogenous events occur in the next year or so. These traumatic events could be anything from a huge California earthquake, Al Qaeda usurping power in Saudi Arabia and strangling the world’s oil supply, or severe weather changes brought on by global warming, etc.
We have suggested that clients who are genuinely concerned about this worst-case scenario keep 1-2% of their portfolio in gold bullion.
Scenario #2: World-wide Deflation. Likelihood = 5-20%. Countries try to protect their economies using tariffs, which sets off retaliation in other countries so global commerce dries up. Shortages become a way of life. Widespread deprivation kindles violence, terrorism escalates, and a large scale war may loom.
Even in this case, the dollar would likely be the world’s safe haven. Decreasing prices enable those who have cash or U.S. Treasury bonds to survive and prosper.
Scenario #3: Recession Reaction. Likelihood – 15-35%. Panic sets off contraction in consumer spending which cascades through the economy. Classic recession response, including lay-offs, unemployment of 10-15% in US, higher in other countries. The Euro may be destabilized by conflicts in monetary policies of member nations. Cutbacks in inventories closes factories; bankruptcies increase. Portfolio Panic Reaction leads many people to take foolish risks.
We work closely with clients to manage their endogenous risks, rebalance portfolios accordingly, make sure that adequate liquidity is maintained.
Scenario #4: Volatility Eruption. Likelihood = 25-40%. We are likely experiencing this phase now. Market prices in securities, commodities, housing, etc. take huge swings in waves of panic trading. Investors retreat to the sidelines, so trading volumes vacillate. This is how the market finds price balance, by testing the extremes. This could be a relatively short phase followed by onset of recession which could be severe, or gradually recover as markets begin to bounce back.
This is most difficult time for investors. In today’s economies this scenario usually stirs government intervention in the markets. This brings the danger that the money supply is increased faster than productivity gains which can trigger spiraling inflation. Having a long-term fixed rate mortgage is the best protection against inflation. Survival in this phase requires clients to turn off the TV.
Scenario #5: Bounce Back. Likelihood = 15-35%. If governments are successful in shoring up confidence in their economies, and adequate liquidity is available in capital markets, stable commerce will again emerge. Housing prices will drop to the point where entrepreneurs can buy up excess inventory and rent out homes with a positive cash flow. New business formations provide most new employment opportunities.
The stock market is likely to start rebounding a year or so before this phase kicks in. Clients guided by Functional Asset Allocation, which we preach, will prosper in this stage since they will not have sold off their stock holdings. Those who have continued dollar-cost-averaging, (e.g. through their 401-k’s, etc.) will enjoy rapid accumulation in their portfolios.
Long-term Outlook. Likelihood – 98-99%. As this downturn is relatively severe, it may take another 2-3 years to substantially recover. Then we will enjoy approximately 5.5 years (on average) of prosperity, which we will soon take for granted. On the next downturn, we will be again surprised. We will go through though another down-cycle as we have for the past century. Again we will think that ‘it is different this time.’ A year or so into that downturn we will again anguish about “How Bad Can It Get?” Then I will send out this blog again, as I did seven years ago in Nov. 2001…
Sleep well tonight! Bert
© Bert Whitehead, M.B.A., J.D. 2008
Monday, October 13, 2008
What Are Your Options Now?
Last month we could take some solace comparing the current bear market to past recessions. Last week, though, was the worst week ever for stocks, dropping 22% over eight trading days. The market is down 36% YTD and the Dow is back where it was in 1998. Even though this recent drop is due to irrational panic, is it time to switch gears?
Before outlining your options, it is still important to keep some historical and global perspective. So far there have been steeper market declines during the 1972-1974 recession and during the 2000-2002 dot-com bust. We are not on the brink of another Great Depression, when the market lost 93% from 1929-1932. Unlike the past, this market cycle is global and the markets in Japan, Britain, Germany, Australia, Hong Kong, India, China and France are all down well over 40%.
Here are your basic options, followed by our commentary:
1) Buy more stocks all at once
2) Buy more little by little (dollar-cost-average)
3) Hold everything to see what happens
4) Hold market position but review and reallocate investments
5) Sell some/all stocks for now and keep in cash, or buy bonds
6) Sell everything and put it in gold or under the mattress.
1) If you are a Gambler, you could take extra cash, or take out a home-equity loan (now offered at 3.99% through Schwab), and put it in the market as fast as you can. This is basically ‘market-timing’ which is always a mistake in the long run, but gives you bragging rights if you are correct (otherwise don’t tell anyone). If you are driven to do this, only do it with a small amount of money (5% or less of your portfolio) and don’t sell your bond ladder to get the cash.
2) Taking extra cash, or using your current 401k contributions, to dollar-cost-average into the market is actually the best option. If you are young enough this is a once-in-a-lifetime opportunity to provide for your retirement so you won’t even need to worry about Social Security (which you may not get anyway).
3) If you are retired, or need some cash flow from your portfolio, holding on to what you have provides peace of mind (assuming you have a balanced portfolio with a 15 year bond ladder with Stripped Treasuries). It is tragic to see how many people are letting money ruin their lives now by watching the news all the time, talking to everybody about how awful it is, mired in angst about whether they should buy or what they should sell. In the long view this will have as much impact on your life as last year’s Super Bowl.
4) Hold but review and reallocate as needed is a great idea. Of course you pay us to help you with this strategy. so we are biased toward this option. We have let you know when major shifts are called for (e.g. sell muni bonds) and can help you execute these changes. We are now reviewing our current portfolio holdings to see if there are better money managers in various asset classes, and will advise you as appropriate. If you are feeling very anxious, it may be a subtle psychological clue that you should have a lower risk portfolio due to endogenous changes in your life (e.g. employment, health, business/real estate risk). If this fits you, please call us to see if your portfolio should be reallocated.
5) Sell! Put it in the bank or buy bonds. This is folly because you are letting your emotions dictate your investments. This is one of the stupid things some smart people are doing with their money. Not only do you have to decide when to sell, but also when do get back in to the market. So you live out the next couple of years on the edge of your seat watching the market. When it goes up, you jump back in, but then get whipsawed as it drops again. So you sell and take your loss. On the next uptick, you lie awake every night wondering if you should buy this time. Get a life!
6) Sell everything and buy gold or put it under your mattress. This is one of the stupid things that stupid people do with money. Sure, keep some cash or gold within reach (not more than 2% of your portfolio) to hedge against financial Armageddon if that is comforting, but it is not an investment strategy.
We hope this outline of your basic investment options will strike a chord with you, and confirm that you are on the right course for your particular situation. If it is unsettling, please email us so we can set up a time to discuss further.
PS The Cambridge strategy of using the 15 year Treasury bond ladder is impacting the industry. See this Oct. issue of Money Magazine:
http://money.cnn.com/galleries/2008/moneymag/0810/gallery.crisis_pros.moneymag/18.html
© Bert Whitehead 2008
Regards,
Bert Whitehead, MBA, JD
Before outlining your options, it is still important to keep some historical and global perspective. So far there have been steeper market declines during the 1972-1974 recession and during the 2000-2002 dot-com bust. We are not on the brink of another Great Depression, when the market lost 93% from 1929-1932. Unlike the past, this market cycle is global and the markets in Japan, Britain, Germany, Australia, Hong Kong, India, China and France are all down well over 40%.
Here are your basic options, followed by our commentary:
1) Buy more stocks all at once
2) Buy more little by little (dollar-cost-average)
3) Hold everything to see what happens
4) Hold market position but review and reallocate investments
5) Sell some/all stocks for now and keep in cash, or buy bonds
6) Sell everything and put it in gold or under the mattress.
1) If you are a Gambler, you could take extra cash, or take out a home-equity loan (now offered at 3.99% through Schwab), and put it in the market as fast as you can. This is basically ‘market-timing’ which is always a mistake in the long run, but gives you bragging rights if you are correct (otherwise don’t tell anyone). If you are driven to do this, only do it with a small amount of money (5% or less of your portfolio) and don’t sell your bond ladder to get the cash.
2) Taking extra cash, or using your current 401k contributions, to dollar-cost-average into the market is actually the best option. If you are young enough this is a once-in-a-lifetime opportunity to provide for your retirement so you won’t even need to worry about Social Security (which you may not get anyway).
3) If you are retired, or need some cash flow from your portfolio, holding on to what you have provides peace of mind (assuming you have a balanced portfolio with a 15 year bond ladder with Stripped Treasuries). It is tragic to see how many people are letting money ruin their lives now by watching the news all the time, talking to everybody about how awful it is, mired in angst about whether they should buy or what they should sell. In the long view this will have as much impact on your life as last year’s Super Bowl.
4) Hold but review and reallocate as needed is a great idea. Of course you pay us to help you with this strategy. so we are biased toward this option. We have let you know when major shifts are called for (e.g. sell muni bonds) and can help you execute these changes. We are now reviewing our current portfolio holdings to see if there are better money managers in various asset classes, and will advise you as appropriate. If you are feeling very anxious, it may be a subtle psychological clue that you should have a lower risk portfolio due to endogenous changes in your life (e.g. employment, health, business/real estate risk). If this fits you, please call us to see if your portfolio should be reallocated.
5) Sell! Put it in the bank or buy bonds. This is folly because you are letting your emotions dictate your investments. This is one of the stupid things some smart people are doing with their money. Not only do you have to decide when to sell, but also when do get back in to the market. So you live out the next couple of years on the edge of your seat watching the market. When it goes up, you jump back in, but then get whipsawed as it drops again. So you sell and take your loss. On the next uptick, you lie awake every night wondering if you should buy this time. Get a life!
6) Sell everything and buy gold or put it under your mattress. This is one of the stupid things that stupid people do with money. Sure, keep some cash or gold within reach (not more than 2% of your portfolio) to hedge against financial Armageddon if that is comforting, but it is not an investment strategy.
We hope this outline of your basic investment options will strike a chord with you, and confirm that you are on the right course for your particular situation. If it is unsettling, please email us so we can set up a time to discuss further.
PS The Cambridge strategy of using the 15 year Treasury bond ladder is impacting the industry. See this Oct. issue of Money Magazine:
http://money.cnn.com/galleries/2008/moneymag/0810/gallery.crisis_pros.moneymag/18.html
© Bert Whitehead 2008
Regards,
Bert Whitehead, MBA, JD
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