Saturday, March 30, 2013

Correct . . . until it is not

I've been studying some new research out of Brigham Young University, of all places.  As you know, the world of stocks is divided into the stock of small companies, middle-sized companies, and large companies.  Those stocks are called small-cap, mid-cap, and large-cap.

Stocks are further dividend into two "styles:"  growth or value.  Growth stocks have market prices that are expensive compared to the book-value of the companies.  Another characteristic of growth stock is that the market price is higher multiple of earnings than value stocks.  Most tech companies are growth stocks.  Almost all dividend-paying stocks are value stocks.

So we have small-cap value stocks, small-cap growth stocks, mid-cap value stocks, mid-cap growth stocks, large-cap value stocks, and large-cap growth stocks.  Now, which is the best investment?

The answer is they are all the best investment but at different times.  So, Brigham Young has looked at the past 23 years, since 1990.  Over that time frame, small-cap value stocks handily beat out all other stock groups.  Their average annual growth was 10.34% compared to 7.6% for large-cap growth stocks, as an  example.

But, are they more risky?  Investment strategists often use standard deviation to measure risk.  Brigham Young found risk was 19.11 for small-cap value stocks, lower than large-cap growth stocks, which was 22.22.

Should we park all our money into small-cap value stocks?  Of course not!  If you did, you would have missed the huge run-up in large-cap growth stocks during the tech-bubble of 1995-99 when they out-performed value stocks by a whopping 8.98% annually.  Looking at 5-year rolling returns, large-cap growth stocks have out-performed large-cap value stocks 58% of the time, while small-cap value out-performed small-cap growth 84% of the time.

While I will probably be more likely to increase my allocation to small-cap value stocks and will be less likely to sell small-cap value when I raise cash, this research is not written on stone tablets from Mount Sinai.  It covers only 23 years and -- you've heard this before -- past performance is no guarantee of future performance.  

Friday, March 29, 2013

Godspeed, Chuck!

One of the main reasons I retired from banking was that it seemed the bank's most "difficult" customers were usually assigned to me.  So, when I started my own practice after retiring, the first rule was "No jerks allowed!"  If I didn't like a client personally, they could not be my client.  The downside is that it hurts me when I lose one, as they are also my friends.

We got the call at eleven o'clock last night that it was time to say good-bye, and we were on-our-way within 15 minutes.  By the time we returned home at four this morning, our emotions were drained flat.  We loved that old guy and will miss him terribly.  After all, he has been my client for twenty years and, like all my clients, he was my friend.

He was a child of the Great Depression, who earned a college degree in 1951 and then great wealth.  Yet, he always lived modestly and remained very humble.  A proud veteran of World War II, he wore his patriotism quietly.  A devout, lifelong Episcopalian, he also wore his love of God quietly.  A husband of almost sixty years, their lives revolved around each other.  They spent countless hours together touring by bicycle.  Their one expensive indulgence was travel, and they traveled the world extensively.

Their greatest heartbreak was the loss of their only child shortly after he graduated from college, when he was hit by a drunk driver.  They always carried that extraordinarily  heavy pain, but they wore it quietly, of course.

Chuck taught me many things.  I tend to be intellectually arrogant, and he taught me humility.  I tend to be confrontational, and he taught me to be more accepting.  I tend to be aggressive, and he taught me good things will come without that.  He made me more tolerant.

He taught me you don't have to wear your money on your wrist.  You don't have to wear your private religion as a public badge.  You don't have to wear your patriotism as a mindless uniform.  You can love all these things, and you can do it privately.  Yes, he taught me much!

Thank you, Chuck, for being my client, my teacher, and my friend.  I miss you terribly.

Wednesday, March 27, 2013

A Migraine for the Count

One of my favorite fictional non-persons is Count von Count on Sesame Street.  He has obsessive-compulsive behavior and must count everything, e.g., the number of blades of grass in a yard or trees in a forest or clouds in the sky.  He should have been an economist, who try to measure everything and explain only some things.

The most nerdy economists are called econometricians.  They are half-economist and half-statistician.  Among other things, they measure the "correlation coefficient," which shows how convincing the economic data should be.  (Unfortunately, it is useless as too few data points are included.)  My guess is that the current economic data is more confusing than convincing to most people.

During an economic recovery, one would expect that huge mass of economic data to be overwhelmingly positive.  While the slight majority of the current economic data does indeed indicatesa recovering U.S. economy, the weakness of that recovery is evidenced by the often contradictory data.

As an example, the stock market is rising right now, but why is it rising when consumer confidence is falling.  Again, isn't that economic data more confusing than convincing?

One explanation is that the market is driven up by all the quantitative easing from the Fed.  Another is that trading volumes are already so low that the market is driven up by the small number of investors who do actually return to the market.  Also, there is evidence the hedge funds have returned en mass.

A better explanation is that consumer confidence data reflects last month, while the stock market reflects the market's expectations for the economy six months from now.  This difference in time perspective is important.  We're comparing backward-looking data with forward-looking data.

As an aside, consumer confidence dropped from 68.0 to 59.7 last month nationwide.  However, in our mid-Atlantic region, it dropped from even more, from 72.3 to only 51.7.  I'll assume this reflects our greater vulnerability to the impact of sequestration, due to our heavy reliance on government spending.

I just hope Count von Count sticks to just counting the many economic data points and doesn't try to make sense of them -- a sure recipe for a migraine!  

Monday, March 25, 2013

Crisis du Jour

As expected, resolution of the Cypriot crisis went down to the wire, and disaster was just barely averted.  In addition, the widely-anticipated shutdown of the U.S. government scheduled for this Wednesday has also been averted, but only to increase the importance and risk of the next debt ceiling increase in a few months.  The European financial crisis is like the American budget crisis, lurching from one crisis to the next.  The world is understandably exhausted with crisis fatigue.

Warren Buffett is fond of saying he has no idea where the stock market will be next week, but he does know where it will be in ten years -- UP!  I think it is more like a terrorist attack, i.e., they only need to be successful once.  Even one crisis can be devastating -- remember Lehman in 2008!  We have avoided the worst-case scenario on every crisis since then.  But, is there another crisis or "black swan" out there?  Of course, there is!

As English poet Samuel Johnson said . . . "nothing focuses the mind like a hanging."  But, he did not say that only a hanging can focus the mind.  It is possible to plan ahead and still assume an occasional disaster.  A cavalier shrug-of-the-shoulders at risk only works in the short run, like a hanging.

Sunday, March 24, 2013

Who Spilled the Gasoline?

It was a clear, pleasant summer day on June 28th, 1914 as Archduke Ferdinand and his wife were being driven in their open car in Sarajevo, when he was assassinated by young Gavrilo Princip.  A month later, Europe plunged into World War I.  That assassination was the burning match thrown into the gasoline.

Not to be alarmist, but it is with that thought that I view the problem in Cyprus.  Fair question -- since our economy is 300 times larger than that of Cyprus, isn't that like worrying about a fly on an elephant?

There is no one answer to that question.  One is that Cyprus banks own a large amount of Greek bonds.  If they are forced to dump those bonds, that will drive down the value, which drives up interest costs for its weak sister, Greece.  Another is that expulsion from the Euro is a real possibility, which has never been done before.  If that happens, there will be even greater chaos in Cyprus than there is already.  Unemployment and food prices will soar.  Gas could easily reach $20/gallon.  While it would probably be beneficial to the Cypriots in the long run, as it would become very cheap to visit or manufacture in that country, there will be much pain and social unrest in the short run.

More importantly, it is the first significant violation of a trust that has held for almost sixty years, i.e., bank deposits should be sacrosanct and protected.  The latest iteration of the Cypriot plan is that large depositors (over 100,000 euros or about $130,000) will lose 20% of the money held in the Bank of Cyprus and 4% in other banks.  Actually, the percentages don't matter -- the sacrosanct status of deposits is far more important.  (To twist the knife even more, the depositors will lose money but not the bank's bondholders.)

The only way to prevent a devastating "run-on-the-bank" is to maintain faith in the safety of the deposits.  It was for that reason that Bernanke wisely removed the cap on FDIC coverage during our crisis in 2008/9.  Now, the question on the lips of every European (and Russian) is whether their deposits are safe anywhere.

There is incredible pressure on the Cypriot and EU leaders who are meeting today, and I wish them well.  However, I'm sure they are aware of the fact that a large amount of the confiscated bank deposits belong to the vicious Russian mafia.  It would be better for the mafia if the EU turns down the Cypriot offer to confiscate Russian deposits in Cypriot banks.  If they accept the Cypriot offer . . . well, thank God for Secret Service protection!

The similarity to the Archduke's assasination is that a relatively minor event leads to huge consequences.  Only a few insiders really know who is holding the credit default swaps (CDSs) on Cypriot debt.  If Cyprus goes bankrupt, who has to pay?  Can they pay?  If your bank deposit is now in a bank that will have to pay but cannot, how would you know?  Where should you move your money to?  I expect the European branches of U.S. banks will receive a large amount of euro-dollar deposits, but it is possible U.S. banks have sold CDS coverage as well and have exposure.

While I do expect this crisis will not likely cause a derivatives blow-up, nobody ever expected Gavrilo Princip to kill Franz Ferdinand either.

Friday, March 22, 2013

Are Existentialists "Born This Way" ?

Like all human beings, existentialists are complex, but the most obvious characteristic is their dispassionate disrespect for death.  Seeing death as a normal part of life, existentialists think of death . . . like Peggy Lee thought of love -- "Is that all there is?"

Through the haze of religious Faith and the passage of time, I remember learning little about death as a child, except for a nagging sense of abandonment.  It was no different than a divorce and no more respectable.

Those veterans who have lost buddies remember an unjust punishment being imposed on them by a faceless, immoral authority that rips a buddy out of your life.  It also didn't deserve respect.

I have a loved one in her fifth month of hospice.  Last week, I lost a 48-year old friend in Richmond, who died suddenly and unexpectedly.  Last night, another loved one was told he has two to six months.

Maybe, I am thinking about death too much.  As a financial advisor, my disrespect for death must be dispassionate enough that my evaluation of economic and financial data remains unbiased.  I must be dispassionate enough to avoid over-reacting to Europe in general and Cyprus in particular.  Fortunately, as an existentialist, I have no problem being dispassionate.

Pop star Lady Gaga sings that people are born however they are, which is like saying a big hunk of raw marble might contain a statue.  It might be marble, but it is not Michelangelo's David.  That takes work!

Wednesday, March 20, 2013

Russia's Cypriot Subsidiary?

In 1992, I was in Switzerland on business, staying at the elegant Hotel des Bergues in Geneva, where I met a man who wanted me to invest with him in starting a bank in Cyprus.  More amused than interested, I listened to him explain an almost wild-west environment for banking in that tiny island nation.  Having served on the Texas State Depository Board during the S&L collapse, I knew it would not end well for Cyprus, and it hasn't.

There are several things about Cyprus that worry me.  Other EU nations got into trouble the old-fashioned way, by promising entitlements they couldn't afford.  But, that was the least of their problems in Cyprus.  Their banks made big investments in bonds issued by Greece, another sickly EU member.  The question is not whether that was a smart investment -- the question is why were they making large, concentrated bets that were un-hedged.  Obviously, the regulators were asleep or lazy or corrupt.

More worrisome, Cyprus became a depository for dirty money from the Russian Mafia, Russian oligarchs, and corrupt Russian officials.  When the Cypriot government agreed to tax/confiscate 9.9% of the deposits over 100,000 euros (which has since been rebuked by their Parliament), the Russian government threatened to withhold natural gas supplies from Germany, the chief advocate of the severe loan conditions for any loan to Cyprus from the EU.

Now, we see the Cypriot foreign minister is in Moscow for "as long as it takes" to negotiate an additional loan plus "other arrangements."  Russia is in a position to turn this little island into a political satellite and a renegade international financial center for the corrupt.

Most worrisome, it might be in the best interests of Russia for Cyprus to leave the EU and the euro, but at what cost to the European Union?  So far, stock markets worldwide have shrugged their shoulders at this possibility, but for how long?

Tuesday, March 19, 2013

Their Choices vs My Money

I don't need any meddlesome busybody from New York City trying to run my life for me.  So, Mayor Bloomberg is not on my "best-friends-for-life" list.  He is trying to violate MY personal options, by outlawing super-large sugary drinks, like Coke.

Last Friday night, my wife and I enjoyed a night out on the town.  It was late when we decided to stop at IHOP, on our way back to the hotel.  However, as we sat there, it was hard not to notice the other diners.

Not once in my life have I ever been called svelte.  When I was first sent to Officer Candidate School in the Army years ago, I was assigned to sit at the "Fat Table" and permitted to eat only half-rations.

Nonetheless, sitting in that pancake palace last Friday night, I realized I was the skinniest man there!?!

They were all around me, eating white flour pancakes, slathered with butter and syrup, washing it down with whole milk and soft drinks.  Don't they know better?  We are bombarded with that information every day!

Then, I started thinking about the estimated $300 billion annual cost of obesity related diseases and wondered why I have to pay for their bad habits.  Their collective lack of responsibility will eventually cost me money!

Curtailing personal options is distasteful -- but not as distasteful as taking money out of my wallet to pay for those who make poor choices.  An alternative to regulating food choices is repricing it.  We tax tobacco, but we subsidize sugar.  Does that make sense?  If the irresponsible cannot control their diet, then they should pay more to eat it.  Shouldn't a large plate of pancakes have a 50% excise tax, increasing the cost to $6 instead of just $4?

Monday, March 18, 2013

Innovative Stupidity

Let's see . . . I could just shoot my foot with a pistol, but that's not very innovative.  Maybe, I could use a rifle to ricochet off a rock before hitting my foot.  No, let's be really stupid!  How about taking a machete and chopping off 9.9% of my foot?

That is how the European Union proposed to deal with Cyprus, which is a tiny EU nation with an economy about the size of Vermont.  But, on a percentage basis, it has a huge banking sector, about eight times larger than the U.S.  For us to have such a large portion of our economy in banking, we would need 25 more JP Morgan giants.  One primary reason their banking sector is so huge is that it is the depository for the Russian oligarchs and Russian mafia, holding billions in dirty money.

So, when the Cypriot banks got into trouble (from making bad bets on Greek bonds), they asked from help.  Like so many banks in Europe, the "Troika" (European Union, ECB, and  IMF) offered a loan -- for most of what was needed, but not all.  For the remainder, they decided to take some of that dirty money to save the banks holding the money.  For deposits over 100,000 Euros, the depositors will lose 9.9% of their deposit.  For smaller deposits, they will lose 6.75%.  Cyprus has something equivalent to our F.D.I.C. to protect their small depositors, but it does not protect small depositors against this confiscation.  Small depositors are getting hurt badly.  Social unrest is a real possibility.

This poses a question that should never be asked:  Is my money safe in the bank?  A "run-on-the-bank" is never a good thing.  Depositors have already started lining up to take their money out of the banks.

If it can happen in Cyprus, why can't it happen anywhere?  Once that thought escapes, it is hard "to put the Genie back in the bottle."

Asia fell sharply overnight.  Europe is down, and the future market indicates the U.S. market will drop.  But, here is the good news:  It was just announced that the deal would be changed, without saying how.  We are currently in "suspended animation."

I have long suspected that "a Jim Fixx moment" or financial heart attack would come from a derivatives blow-up in Europe, and I'm watching this carefully.

Friday, March 15, 2013

Even Bulls Should Rest

The stock market has been very bullish since Christmas.  Maybe, it is too bullish and needs to "bump along" for awhile before resuming its climb?

It has behaved relatively normal since its March, 2009 low.  Compare it with some other market rallies:

Chart of the Day
You'll notice the current rally most closely tracks the rally following Nasdaq's crash in 2000.  It is nowhere near as robust as the 1932 rally, which promptly crashed again (not shown above).

But, the market is now 9% above its 200-day moving average.  That is clearly not sustainable.  Former Fed Chairman Alan Greenspan said he doesn't see any "irrational exuberance" in the stock market today.  I think he is right -- long term.

The market needs to stop going up in the short term and start consolidating its gains, or it will not be sustained.  The Dow has now risen for ten straight days, for the first time in seventeen years.  That is too much of a good thing!

You've been a good bull!  Now, go play in the pasture for awhile . . .

Thursday, March 14, 2013

Speaking The Language of Risk

One of our speakers this week said there is a difference in the way older clients use the term "asset allocation" and the way financial advisors use that term.

Older clients use the term to reflect their risk appetite.  A client with a high appetite for risk might have 90% of his portfolio in stocks, for example.  (Normally, as a person ages, the percentage of their portfolio allocated to stocks decreases.)  Clients see risk in terms of two asset classes:  stocks and bonds.  They see stocks as risky and bonds as safe, which still remains the conventional wisdom, unfortunately.

Financial advisors are schooled in Modern Portfolio Theory, which believes an allocation of funds into different asset classes will improve returns and reduce risk over the long term.  They see many different asset classes, including:  large cap value stocks, large cap growth stocks, mid-cap growth & value stocks, small cap growth & value stocks, international stocks, emerging market stocks, cash, currencies, precious metals, long term corporate or government bonds, short term corporate or government bonds, managed futures, real estate, commodities, and so forth.  To a financial advisor, asset allocation asks the question of how much to allocate to each of these asset classes and is not a measure of risk.

It is therefore the duty of the financial advisor to listen carefully to his client.  If the client says he wants a 60% allocation to stocks, he is saying that he wants to take some risk, so he can hopefully enjoy some good performance, but don't go overboard.  It is also the duty of the financial advisor to explain that many individual stocks are far safer than bonds, even while producing better income than bonds.  It is especially important that the financial advisor explain that long term bond funds are especially dangerous.

Our speaker didn't discuss how younger clients might be using the term differently, but I can still remember the days when I thought I was bulletproof and couldn't even define risk, much less worry about it.  Oh, how things change . . .

Wednesday, March 13, 2013

Talking His Book . . . or not?

There are two types of stock analysts on Wall Street, i.e., buy-side analysts and sell-side analysts.  If an analyst works for a mutual fund, he is looking for good stocks to buy and is called a buy-side analyst.  If he works for a brokerage house, he is probably looking for good new stocks to sell to investors and is called a sell-side analyst.  Not surprisingly, the analysis of buy-side analysts is much more believable than the analysis by the sell-side analysts.  Everybody knows a sell-side analyst is "talking his book" or shading his analysis to make you buy whatever he is selling.

I listened to a presentation by a doctor that said financial advisors have an obligation to prepare our clients for Obamacare . . . by fleeing it.

His argument is this:  Obamacare is well-meaning, because another 40 million people will finally get the health care they need.  Of course, this creates the need for more general practitioner physicians to serve the 40 million new patients, and Obamacare does make some minor provision to increase the number of general practitioners.  Unfortunately, that part of Obamacare is deeply flawed, because it doesn't recognize that new graduates from medical school are forced to become higher-paid specialists in order to payoff their crushing education loans.

Slowly, it will be increasingly difficult to get an appointment to see your local general practitioner.  At the same time, affluent patients will begin migrating to the newest delivery system for medical care, which is concierge care.  Under this arrangement, the patient pays an extra flat fee each year of, say, $3,000.  He is then assured of receiving immediate personalized care 24/7.  Of course, there are additional "fee-for-service" charges each time you receive medical care, which are billed to Medicare or your insurer.  You get much better, faster care and pay for it.  It is not for everyone.  But, what happens when the concierge doctors get overwhelmed with new patients?  They stop taking more patients, and the rest are stuck in Obamacare.

All of this makes sense to me, except the speaker was the doctor who was drumming up business for his own concierge care business.  Does that make him a sell-side analyst who is merely "talking his book?"  Or, is he a true-believer?

So, does a trusted financial advisor have an obligation to urge his clients, all of whom are affluent, to contract with a concierge medical care provider now, while they are still accepting new business?

Tuesday, March 12, 2013

Wisdom From The Birds of Hell

Sometimes, another person's real-life experience can make a theoretical concept understandable.  Today, I attended a lecture in Orlando and listened to a person describe such an experience.

(Truth In Blogging:   Modern Portfolio Theory is the most widely-accepted theory of investment management, but I have written numerous times about my reservations with this theory.  His experience exemplifies just one reservation with it.)

One of the basic concepts of Modern Portfolio Theory is that all investors are rational individuals making decisions in their own self-interest.  Because their interests vary, their decisions will vary but will always be rational and independent.  This is a fancy way of saying they are non-correlated.

It also explains how asset classes react to each other.  They are non-correlated, which means some will go up while others go down.  This concept of being non-correlated is important to understand Modern Portfolio Theory.

Our speaker told of his experience when he boarded flight 1549 on January 15, 2009, flying from New York to Charlotte, with 150 non-correlated passengers, who each had their own plans for the future.  However, shortly after lifting-off, the plane was "attacked by the birds of Hell," causing the plane to lose power.  The plane became quiet as it started descending -- until it landed on the Hudson River and then floated five miles downstream.

Most interestingly, he described the four and a half minutes they spent, after losing power but before they learned their fate by landing in the freezing river.  The 150 non-correlated individuals became one - staring into the face of death.  They all wanted the same thing -- to avoid death.  They became fully correlated to each other.

This, he explained is the problem with Modern Portfolio Theory.  Investors are non-correlated -- until they get scared.  Then, they just want to sell.  Our speaker even explained that the brain uses the same neural pathway for the fear of airplane crashes and the fear of stock market crashes.

That was an obvious result during the 2008/9 crash.  Investors behaved the same - they sold.  Asset classes behaved the same - they fell.  In a crisis, decisions become correlated.

As I have said before:  Modern Portfolio Theory works great . . . until it doesn't!

Monday, March 11, 2013

An Ayn Rand Haircut

How can a haircut be memorable?  Last week, I got a haircut from a new barber.  Everything was fine, until she asked if I had heard about the young child who was fully cured of HIV, the first person to actually be cured.  Of course, I was aware of it and told her I was thrilled at the good news.

After a pause, she asked me if I was surprised the government had allowed such information to be released.  My response was that I didn't know if the government had any control over that information or not, and that I couldn't imagine why any government anywhere would suppress such good news.  Apparently, she sensed I thought it was a dumb question, as she backed off.

Since then, I continue to marvel at this notion that "the government," whatever that means, would hide such news as a cure for AIDS.  Would it be because they were concerned people would no longer practice "safe sex?"  Is it because they want to make people "disappear" by claiming they were infected when they were not?  What would be the motive of this evil government?

Again, I trace this notion back to the writings of the best-selling writer, Ayn Rand, that refugee from the Communists following the Russian Revolution who popularized the notion of government as evil in her classic books, Atlas Shrugged and Fountainhead.

I love Ronald Reagan, who famously said "government is not the solution, government is the problem."  But, he didn't say the government is evil and incompetent.  He said it was stupid and incompetent.  Think about it -- that is a huge difference.  Motive matters!

Have government bureaucrats ever lied to us?  Of course, they have!  But, so have businessmen and clergymen.  Has the government lied to us enough that we should fret about black helicopters landing in your front yard?  If you're an Ayn Rand disciple, you might worry all night.  However, I'm an Ayn Rand student and sleep like a baby!

A paranoid barber with a razor in her hand may not be good company.  Anybody know a good barber?

Saturday, March 9, 2013

The Joy of Spin

Real estate prices are rising again!  Wall Street is rising again!  The net worth of America has been restored! The global financial crisis that began six years ago wiped out about $16 trillion of our collective net worth.  The good news is that we are once again worth a whopping $66 trillion.

The bad news is that inflation over the last six years makes that number less meaningful.  Plus, there are now more of us than in 2007, reducing our net worth per person.

Take a look at this graph.  Democrats can argue we have now recovered, and Republicans can argue we have recovered very little.  And, they're both right!

Friday, March 8, 2013

Snakes in Planes . . . Or, Farmers in Condos

A "short-seller" is a type of investor who bets that the value of something will decrease.  It is a very risky investment technique that I NEVER use, because you can lose -- not only the amount you invest -- but also EVERYTHING you own.

One of the most famous and most successful short-sellers in the U.S. is Jim Chanos.  Three years ago, I saw him on CNBC predicting the collapse of Chinese economy, primarily due to over-building in residential construction.

Two years ago, I went to China and did indeed see an enormous amount of residential construction.  However, from my previous studies of China, I was aware of the hyper-sensitivity of the country's Communist leadership toward social unrest, which could easily be aggravated by the mass movement of people from the rural areas to the cities.  I was told many times that the breakneck level of construction was necessary to maintain "social peace."

Last Sunday, there was an excellent story on Sixty Minutes about all these ghost buildings and even ghost cities.  Suddenly, the subject of a Chinese real estate bubble was on everybody's lips.

Little noticed on Tuesday, the Chinese government announced a simplified approval process for the huge backlog of applications from citizens seeking to migrate from the farms to the city, in order to fill-up all this empty real estate.  The backlog is so great they could reduce vacancy enormously almost overnight.

I knew there was a grain of truth to what I was told a few years ago that the excess residences were built to accommodate the migrants.  There still is . . . a grain of truth, that is.  However, that does not mean there has been no waste!

If you are providing a $400 thousand residence to every worker who can only afford a $250 thousand residence, you have wasted $150 thousand of the nation's multi-trillion dollar reserves.  Any other nation would certainly be experiencing a real estate bubble, but China may be the first nation that can afford it.  This is not to say China doesn't have a debt problem, because it does, but it is a private debt problem, not a government debt problem.  Also announced on Tuesday were increased restrictions on real estate lending.  Unlike many nations, China can make a decision.

What makes a real estate bubble so damaging to the economy is that it usually produces a financial crisis, but what happens if it doesn't?  It is over-reach to suggest the Chinese real estate bubble will be as dangerous as the U.S. real estate bubble.

Wednesday, March 6, 2013

Rooting For Sequestration

We've all heard that sequestration will be bad for the economy.  Therefore, you would expect financial advisors would be opposed to it.  You would be wrong!

A survey last week found a whopping 66% of us were in favor of it.  Bring it on!  We're in favor of it, despite the fact that 74% thought the economy would definitely be hurt.  That's because 73% of us concluded the short-term pain to the economy would be worthwhile over the long-term.

Because financial advisors are notoriously Republican, it should not be surprising that 51% believe the President is to blame and only 17% blame the Congressional Republicans.  28% think both sides are equally guilty.

Frankly, that does not surprise me.  However, I would be surprised if my fellow advisors are so sanguine about a government shutdown later this month or, even worse, a debt default if the debt ceiling is not raised later this year.  We'll see . . .

14,253.77 Is Just Another Number

It has been a long, hard four years since the Dow touched its low on March 9th, 2009, before bouncing back almost 118% to close yesterday at its new all-time high.  Yes, I'm happy about it!  Who wouldn't be happy about a graph like this?

Chart of the Day

But, I would be more happy if this graph was adjusted for inflation, if the much more significant S&P 500 was higher, if the Nasdaq wasn't still 35% below its all-time high, if the Fed was not pumping $85 billion worth into the market every month, and if the economy was performing as well as the stock market.

Of course, the world today is very different from 2007, the last time the Dow was this high.  That was before the global financial crisis of 2008 when Lehman collapsed, before unemployment rose above 10%, before the debt debacle of 2011, and before Europe peaked into the abyss of financial collapse.

In 2007, we did not suspect there would be a derivatives blow-up in U.S. mortgage-backed-securities.  In 2013, we worry about another similar derivatives blow-up in Europe.  Maybe, we worry too much?

The beauty of capitalism is that it adjusts, however painfully, to adversity and eventually recovers.  The Dow proves that!  According to "Dow Theory," a new high in the Dow Jones Industrial Average is judged to be truly bullish IF the Dow Transportation Average also reaches a high.  This did in fact happen yesterday, suggesting the bulls have plenty of room to run.  This is a big deal to market technicians.

Hopefully, the 30 stocks in the Dow will continue to rise, but it would be better if the Dow takes a break, consolidates its gains, and waits for the rest of the broader market to catch up.

Tuesday, March 5, 2013

The Freedom To Be Honest

I don't understand why investors do business with banks.  Except for checking accounts, what good are they?  They don't make loans when customers need them.  They put their customers in all sorts of "goofy" investments.  And, they charge all sorts of hidden fees.

Did you read this article on the front page of Sunday's Wall Street Journal:

While this article pertains only to JP Morgan, it describes all of the big banks.  I was fortunate that I could retire when instructed to put my clients into investments I disliked or distrusted or wrong for the client.

The banks "jumped the rails" or lost their way when they decided to become "sales organizations."  In economics, banks are allocators of credit, not salesmen.  They lost their economic function and their way.  It would not have been so bad, except it corrupted the salesmen into selling hazardous sub-prime mortgage-backed-securities and derivatives that nobody understood.  These salesmen have spent the last five years enjoying the millions they made -- giving a bad name to everybody in the investment business.  And, they are guilty of nothing more than working their incentive plan??

If you are asked whether an investor should use a banker, a stockbroker, or a Registered Investment Advisor, I do hope you'll recommend the only one who is free to pick the right investments for the investor and charges no hidden fees -- the RIA.

Monday, March 4, 2013

To Re-Balance Or Not To Be

During my first year in the Army, I was trained in the strategy and tactics of conventional warfare.   During my second year, I was trained in unconventional warfare.  I've always felt that this one-two approach to almost any subject has served me well.

According to Wikipedia, conventional wisdom is "the body of ideas or explanations generally accepted as true by the public or by experts in a field. Such ideas or explanations, though widely held, are unexamined."  Unconventional wisdom is the opposite, but does that make it wrong?  Of course not!

According to conventional investing, portfolios should be "re-balanced" periodically.  An example would be to sell stocks and buy bonds after a bull run in the stock market, because stocks would be a higher percentage of your portfolio than you might be comfortable with.  If you want your portfolio to be 60% invested in stocks and it is now 65%, you should sell stocks equal to 5% of the portfolio.  Like most arbitrary rules, it is more interesting than valuable.

How does one reconcile the notion of re-balancing with one of The Street's oldest adages:  "Ride your winners and sell your losers"?

The answer is they cannot be reconciled.  Re-balancing can be accomplished by computer programs without any human input.  It gives the impression of action, even when none is needed.  If you think the market will continue rising, why would you want to reduce your exposure or get out?

Re-balancing is not bad.  In fact, it is good.  But, it should be done when your investment perspective changes, not according to some calendar.

If you want to reduce risk, then by all means, sell some stocks.  But, don't buy long-term bonds when interest rates are low, like they are today.  A computerized program to sell your stocks and buy long-term bonds is virtually guaranteed to lose money for you.  Beware of arbitrary rules!

Of course, part of unconventional warfare is dis-information.  And, reliance on such arbitrary rules like periodic re-balancing, especially computerized re-balancing, is the same as relying on dis-information.  It is like fighting an unconventional war with conventional tactics.

See . . . I did learn something in the Army!

Sunday, March 3, 2013

Don't Look Behind the Curtain

Readers will recall my tongue-in-cheek New Year's Resolution was to become chairman of the Republican National Committee (RNC) in order to save the party from its extremists.  America needs the Republican Party, the Grand Old Party, but it is being abused by extreme purists.

The sequester is expected to decrease 2013 GDP by 0.6%, according to the CBO.  This is not crushing, just stupid.  One pundit on Fox described it as cutting off two toes when the doctor said your body mass index is too high.  Instead of losing weight in the belly, which is necessary, the patient just cuts off something else, which is just stupid.

Depending on how you measure it, entitlements now make up about 43% of our total budget, and it is still rising more rapidly that any other major line item in the budget.  Entitlements refer to Medicare, Medicaid, and Social Security.  These incredibly expensive programs are also incredibly popular.  Of course, if I can borrow money from another generation and never have to repay it, why wouldn't I like it?

For every one dollar we spend on the next generation, we spend $4.20 on the last generation.  Even worse, 40% of that money is borrowed.  Is the purpose of government to take care of old people?  I can at least ask that question, because I will soon be 66 years old.  I'm already on Medicare and eligible for Social Security in a few months.  Is taking care of me the primary function of government?  What makes it un-American to ask whether I "deserve" such largess from other taxpayers?

Sequestration reflects our national inability to focus on that question.  Failure to focus on that crucial issue is damaging our military and delaying infrastructure development and decreasing GDP.

This stupid idea of sequestration came from the President, who readily admits it is stupid.  His calculus was that the Republicans would never allow the Pentagon to be gutted.  I would have agreed that Republicans would never throw Defense under the bus . . .at least Ronald Reagan would not have.  But, the extreme purists in the G.O.P. have no problem doing so.

The biggest problem with sequestration is it makes us too sanguine about future policy.  Only one in four Americans are even following the story.  Call it "policy-fatigue."  Like the frog who is boiled to death if the water temperature is raised slowly enough,  sequestration raises the water temperature just before we have a government shutdown on March 28th.

Sequestration and government shutdowns can damage the economy but are unlikely to cause a financial crisis.  The third ring in this three-ring circus is raising the debt ceiling, which looks like it will be in July or August.  That could cause a much more serious problem.

All of this because we will not focus on the issue of how much our GDP should be spent on Medicare, Medicaid, and Social Security.  We'd rather focus on cutting off our toes than losing belly fat.

One problem with extremists is that they force moderates to defend the other side, out of some sense of fairness.  Republicans want to give the President authority to allocate the spending cuts in sequestration, because it will expose his priorities and provide lots of ammunition for later battles.  Well, he has already offered two cuts in the far-more-important battle over entitlement spending, i.e., chain-weighted cost of living increases and means-testing.  That is a big deal as an opening bid.  Republicans could improve upon this by negotiation.  But, they are afraid the voters will punish them for attacking these popular but wasteful programs.

Politicians are afraid to pull back the curtain and face older voters . . . like me!  So, we cut everything else?? We cut the things that don't need to be cut but but not the things that do need to be cut.  Yes, that fits the definition of stupid!

Friday, March 1, 2013

A Little Fresh Air

The media pays a lot of attention to the fact that the U.S. stock markets are near multi-year highs, they ignore the fact that we are still lagging China, England, Japan, Switzerland, even Argentina and Dubai.  Take a look at this graph:

Gold Production Growth vs. Per Share Gold Growth

The two best performers are both emerging markets, which are usually considered more risky.  Also note that Europe has risen.  In the long run, I'm extremely bullish on Turkey, but their market is down for the year, as is Brazil.

Now, isn't that better than trying to blame somebody for sequestration?  You're welcome!

See, you can spend your time on thinking about something else . . .