Archive for September, 2010
“Those who don’t know history are destined to repeat it.”
- Edmund Burke – British Statesman and Philosopher (1729-1797)
I wasn’t a history major in college, but I’ve learned two things by studying history books: 1) The unchanging psyche of human nature leads history consistently to repeats itself; and 2) There is never a shortage of goofballs willing to make zany predictions.
Robert Zuccaro is no exception to lesson number two, as evidenced by his 2001 book, Why it’s Different this Time…Dow 30,000 by 2008! Sticking one’s neck out is never too difficult when you have a multi-decade trend behind your back – I guess Dow “14,000” just didn’t sound sexy enough back then. Unfortunately the herd reacting to these bold, extreme predictions eventually realize (usually post-mortem) that they are quickly approaching a tail-end of a cycle. The cab driver, hair dresser, and mechanic realized the dangers of following the “New Economy” cheerleaders in 1999 when everyone was piling into dot-com stocks (see Bubblicious technology table ).
Dow 1,000 Here We Come!
Today, the Zuccaros of the world have been washed to the curb, and new “Armageddon” extremists have sprouted up to the surface, like perma-bear Peter Schiff and his call for Dow 2,000 or his $5,000 per ounce gold estimate. More recently, Robert Prechter has one-upped Schiff by forecasting Dow 1,000 with the assistance of the not-so ironclad Elliott Wave Theory philosophy (see Technical Analysis: Astrology or Lob Wedge). If you’re in the Prechter camp, either crawl back into your bunker or start digging that dream cave you always wanted.
“Hey, Look Here at My Crazy Forecast!”
Publicity doesn’t necessarily rain praise on those parroting the consensus view (although the warmth of job security is appreciated), but rather the extreme outliers love to bask in the glow of media attention. The extremists consistently repeat “why it’s different this time.” What is different is the set of circumstances, but what history shows us over and over again is the emotions of fear and greed feeding the bubbles of excess are exactly the same. Whether you’re talking about the Tulip-Mania of the 1630s, the Nifty Fifty stocks of 1973-1974, the technology Four Horsemen of the mid-1990s, or the Icelandic Banks of 2008, what we learn from the lessons of history is that human nature will never change and fear and greed will continue creating and bursting future bubbles.
People playing the game long enough understand, “It’s NOT different this time.” Not only have we endured repeated wars, recessions, banking crises, currency crises, but we have also survived every exotic animal disease known to man, including Mad Cow, Swine Flu, Bird Flu, West Nile, etc.
Robert Zuccaro and Robert Prechter may get an “A” for their attention grabbing forecasts, but thus far the grade earned on accuracy is closer to an “F.” More specifically, Zuccaro’s prediction never came close to 30,000 by the end of 2008 (only off by about 21,000 points), and guess what, Bob Prechter has a long way to go before reaching his Dow 1,000 target. So here is my proposition: Why don’t we just split the difference between Zuccaro’s 2008 and Prechter’s 2016 forecasts and take the average? If it turns out they are equally bad forecasters, then Dow 15,500 by 2012 should be no problem ([30,000 + 1,000] ÷ 2)!
Regardless of the ultimate outcome of this market (double-dip or sustained recovery), what I do know is there will continue to be wacky outlandish forecasters rationalizing why a trend will go on for infinity and why “this time is different.” In reality these attention mongers will always be around ensuring this time (or next time) will never be different…just the same fear and greed as always.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Government politicians and voters have made it clear they do not want to bail out “fat-cat” bankers in the private sector, but what about bailing out “fat-cat” state pensioners in the public sector? States and cities across the country are increasingly under economic strain with deficits widening and debt-loads stacking up. California’s statewide budget problems have been well publicized, but you are now also hearing about more scandalous financial problems at the city level (read about the multi-million dollar malfeasance in the city of Bell).
Well if a 2010 $1.3 trillion federal deficit is not enough to tickle your fancy, then how does another $137 billion in state deficits over fiscal 2011 and 2012 sound to you (National Governors Association)? Unfortunately, the states have made no meaningful structural improvements. If you layer on general economic “double dip” recession fears with excess pension liabilities, then you have a recipe for a major unresolved financial predicament.
Despite the dire financial state of the states, municipal bond prices have generally survived the 2008-2009 financial crisis unscathed. With unacceptably poor state budget risks, muni bond prices have continued to rise in 2010. The downside…new investors must accept a pitiful yield of 2.75% on 10-year municipal debt, according to Financial Advisor Magazine.
One investor who is not buying into the strength of the tax-free municipal bond market is famed investor and CEO of Berkshire Hathaway (BRKA/BRKB), Warren Buffett. Here is what he wrote about munis in his legendary annual shareholder letter last year:
“Insuring tax-exempts, therefore, has the look today of a dangerous business…Local governments are going to face far tougher fiscal problems in the future than they have to date.”
Buffett has this to say about rating muni bonds:
“I mean, if the federal government will step in to help them [municipalities], they’re triple-A. If the federal government won’t step in to help them, who knows what they are?”
Safety Net Disappears
Like a high wire artist dangling high in the air without a safety net below, the states are currently borrowing money with little to no protection from the bond insurance providers. The shakeout of the subprime debt defaults has battered the insurers from many perspectives, leaving a much smaller market in the wake of the financial crisis. In 2007 about 50% of new municipal bonds were issued with bond insurance, while today only approximately 7% carry it (UBS Wealth Management Research). With decreased insurance coverage, the silver lining for muni investors is the necessity for them to perform more comprehensive research on their bond holdings.
Defaults on the Rise
On the whole, less insurance will result in more defaults. Although defaults are expected to decline in 2010, non-payments totaled $6.9 billion in 2009, up from $526 million in 2007 (Distressed Debt Securities). Even though the numbers sounds large, the recent default rate only represents a 0.25% default rate on the hefty $2.8 trillion market. That muni default rate compares to a more intimidating corporate bond default rate of 11% in 2009.
Bigger Bark Than Bite?
James T. Colby, senior municipal strategist at Van Eck Global, understands the severity of the states’ budget crisis but he believes a lot of the doomsday headlines are bogus. Riva Atlas, writer for Financial Advisor Magazine, summarizes Colby’s thoughts:
“Even those states in the worst straits like California and Illinois have provisions in their constitutions or statutes requiring them to pay their debts. In California, the state’s constitution says bondholders come second only to the school system, so the state would have to empty its jails before it stopped paying its teachers.”
Certainly municipalities could raise taxes to compensate for any budget shortfalls, but we all know most politicians are reluctant to raise taxes, because guess what? Tax increases may result in fewer votes – the main motivator driving most politicians.
If the states decide to not raise taxes, they still have other ways to weasel out of obligations. For starters, they can just stick it to the insurance company (if coverage exists). If that option is not available, the municipalities can look to the federal government for a bailout. Irresponsible actions have their consequences, and like consumers walking away from payments on their mortgages, municipalities will effectively be preventing themselves from future access to borrowing. Either way, the bark is less than the bite for investors since the insurance company or federal government will be making them whole.
BABs and Taxes Add Fuel to the Fire
A glut of Build America Bonds (BABs) issued by municipalities, driven by demand from yield hungry pension funds, along with expected tax hikes for the wealthy have created a scarcity of tax-free munis.
In the first half of 2010 BABs accounted for more than 25% of municipal bonds issued, which was a significant contributing factor to the robust muni market. The BABs tailwinds aiding muni prices won’t last forever, as the bond issuance program is expected to expire at the end of 2010.
On the tax front, the wealthy are likely to see higher federal tax rates in the future – upwards of 36% – 40%. If you include the double tax-exempt benefits in states like New York and California, the relative attractiveness becomes even that much better. Combined, these factors have elevated muni prices.
Despite higher defaults, scarier headlines, and the lack of insurance, the municipal bond market remains robust. General interest rate declines caused by macroeconomic fears have caused investors to flock to the perceived “safe haven” status of Treasuries and Munis, but as we have all witnessed, the fickle pendulum of emotions never sits still for long.
Managing the Munis
As is evident from the municipal bond discussion, states and cities across the country have been plagued by the same deficit and debt issues as the country faces on a federal level. Tough structural expense issues, and revenue generating tax policies need to be scrutinized in order to prevent federal taxpayer bailouts of municipalities across the country.
From a municipal bond investor perspective, it’s best to focus on general obligation bonds (GOs) because those bonds are backed by the taxing authority of the municipal government. On the flip side, it’s best to stray away from revenue bonds or privately issued municipals because revenue streams from these bond channels are not guaranteed by the municipality, meaning the risk of default is larger.
While Congress sorts out financial regulatory reform with respect to banking bailouts and “too big to fail” corporations, our federal government should not lose sight of the widespread municipality problems our country faces today. If not, get ready to pull out the checkbook to pay for another taxpayer-led bailout…
Read the Complete Financial Advisor Magazine Article: The Muni Minefield
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including CMF), but at the time of publishing SCM had no direct position in BRKA/B or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Oh Nelly, take it easy…don’t get too crazy on that bunny slope. With fall officially kicking off and the crisp smell of leaves in the air, the new season also marks the beginning of the ski season. In many respects, investing is a lot like skiing. Unfortunately, many investors are financially skiing their investment portfolios down a bunny slope by stuffing their money in low yielding CDs, money market accounts, and Treasury securities. The bunny slope certainly feels safe and secure, but many investors are actually doing more long-term harm than good and could be potentially jeopardizing their retirements.
Let’s take a gander at the cautious returns offered up from the financial bunny slope products:
That CD earning 1.21% should cover a fraction of your medical insurance premium hike, or if you accumulate the interest from your money market account for a few years, perhaps it will cover the family seeing a new 3-D movie. If you also extend the maturity on that CD a little, maybe it can cover an order of chicken fingers at Applebees (APPB)?!
We all know, for much of the non-retiree population, the probability that entitlement programs like Social Security and Medicare will be wiped out or severely cut is very high. Not to mention, life expectancies for non-retirees are increasing dramatically – some life insurance actuarial tables are registering well above 100 years old. These trends indicate the criticalness of investing efficiently for a large swath of the population, especially non-retirees.
Let’s Face It, One Size Does Not Fit All
As I have pointed out in the past, when it comes to investing (or skiing), one size does not fit all (see article). Just as it does not make sense to have Bode Miller (32 year old Olympic gold medalist) ski down a beginner’s bunny slope, it also does not make sense to take a 75-year old grandpa helicopter skiing off a cornice. The same principles apply to investment portfolios. The risk one takes should be commensurate with an individual’s age, objectives, and constraints.
Often the average investor is unaware of the risks they are taking because of the counterintuitive nature of the financial market dangers. In the late 1990s, technology stocks felt safe (risk was high). In the mid-2000s, real estate felt like a sure bet (risk was high), and in 2010, Treasury bonds and gold are currently being touted as sure bets and safe havens (read Bubblicious Bonds and Shiny Metal Shopping). You guess how the next story ends?
Unquestionably, coasting down the bunny slopes with CDs, money market accounts, and Treasuries is prudent strategy if you are a retiree holding a massive nest egg able to meet all your expenses. However, if you are younger non-retiree and do not want to retire on mac & cheese or work at Wal-Mart as a greeter into your 80s, then I suggest you venture away from the bunny slope and select a more suitable intermediate path to financial success.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, and WMT, but at the time of publishing SCM had no direct position in APPB, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Average investors feel ill from the 2008-2009 financial mess, and like hypochondriacs they can only find fleeting reassurances by reviewing endless amounts of unemployment data. Volatile monthly data is not sufficient, so even more erratic weekly jobless claims data are relied upon. Why just stop there? With this insatiable appetite for unemployment rate data right now, people can’t get enough, so I am not only petitioning for the release of a daily jobs report, but also an hourly one.
Jobs data are relatively straightforward and simple for most Americans to understand. However, most people have more difficulty connecting with economic acronyms and data points such as GDP, PPI, CPI, industrial production, Philly Fed, capacity utilization, Conference Board LEI, durable goods, factory orders, energy inventories, trade balance, unit labor costs, and other economic figures.
What’s the big deal surrounding the infatuation with myopic unemployment data? We have these things called “recessions” about twice every decade, and of the last 11 post-WWII recessions we have had 11 recoveries – not a bad batting percentage. Obviously, unemployment is a big deal if you are one of the 15 million or so people with no job, but as Jim Paulsen, Chief Investment Strategist at Wells Capital Management points out in his August Economic and Market Perspective, this current recovery is progressing at the fastest pace of any recovery over the last 25 years, and yes, jobs are being added (albeit slower than hoped).
“The consensus perception that this recovery is the ‘worst ever’ and consequently extremely vulnerable to a potential double-dip recession is overblown…Even if this recovery is weak compared to older postwar norms, it is still stronger than any other recovery in the last 25 years,” states Mr. Paulsen.
As you can see from Paulsen’s table below, our current recovery is not as brisk as the recoveries in the pre-1983 era, but he chalks up this trend to subpar growth in the United States’ labor force.
Paulsen identified this dampened worker growth since the mid-1980s. He doesn’t attribute moderate growth to the “New Normal,” as described by PIMCO pals Bill Gross and Mohamed El-Erian (see also New Normal is Old Normal), but rather ascribes the phenomenon to a continuing trend. Paulsen adds:
“Whatever is causing the ‘new-normal’ economy has been doing it for the last 25 years. The ‘new normal’ is actually kind of old—at least a quarter century old.”
If you think about it, what businesses carried out over the last two years is clearly consistent with a normal economic recovery:
1) Businesses fired employees swiftly amid great uncertainty.
2) Businesses cut expenses, especially discretionary ones, and now profits and cash are piling up.
3) Businesses are buying more capital equipment. Spending is up +12% (to ~$1.3 trillion) from early 2009 according to Joe Lavorgna, an economist at Deutsche Bank.
4) Business acquisitions are beginning to heat up. Witness BHP Billiton’s (BHP) bid for Potash Corp (POT), and HP’s (HPQ) bid for 3Par (PAR) as examples (read HP’s Winner’s Curse).
5) Businesses are paying larger dividends and buying back more of their own stock.
All these actions are very reasonable given the continued uncertain economic environment and rapidly building cash war chests. Buying back stock, doing acquisitions, and prudently spending on cost saving equipment are, generally speaking, accretive measures for a company’s profit and loss statement. On the other hand, hiring employees is usually a lagging indicator of economic expansion and acts as diluting profit forces – at least in the short-run until workers become more productive. Eventually cash and/or business confidence will rise enough to push human resource departments over the fence to begin hiring again.
The weekly unemployment claims chart shows how rapidly improvement has been achieved over the last few decades, even though the improvement has stalled at a lofty level.
Japan Case Study: Demographic Double Edged Sword
Be careful what you wish for. Low unemployment is not the end-all, be-all of the world we live in. Take Japan for example. From 1953 until 2010, Japan’s unemployment rate averaged about 2.6%. The last reported rate registered 5.2% in July, double Japan’s average, but almost half of the U.S.’s current 9.6% rate.
Why does Japan have lower unemployment? There are numerous reasons cited – everything from over-employment in the agriculture sector to uncounted married women and protective conglomerates to better disincentives in unemployment insurance program. Overshadowing these reasons is the unmistakable aging of the Japanese population. The National Institute of Population and Social Security Research predicts the Japanese population will fall 30% to 90 million by 2055. Low birthrates, limited immigration, and retirement all increase demand for employment, therefore Japan’s younger-age workforce becomes a scarcer resource and will be more likely to secure and maintain employment. Eventually, I will become old enough in retirement that I will need my underwear and bedpan changed, and create a job for someone in the process – a job that cannot be outsourced I may add. Of course there are very few countries that want a declining population, even if it may lead to an improved unemployment rate. A growing country with liberal immigration laws, healthy birthrates, abundant resources, and pro-business initiatives may have higher unemployment rates but also have more jobs available because of the growing workforce.
Eventually the 76 million Baby Boomers born between 1946-1964 are going to be exiting the workforce and will increase the burden on our younger workforce. Do we want to follow in the same path of Japan? Or do we want to adjust our legislative process to meet the draining demands of our aging society? My answers are “No,” and “Yes,” respectively.
The unemployment hypochondriacs can take a deep breath knowing the path we are experiencing is nothing new. Certainly I would like to see better policies implemented to accelerate the economic recovery, but regardless of what inept politicians bungle, our innovative companies, and restless voters are waking up to keep our representatives accountable. This is important because we are like a younger but stronger cousin of Japan, and we do not want to follow along the decaying path of an aging indebted country. In the short-run, we all want to see job growth for the millions of unemployed. In the long-run, retiring Boomers will be stretching the resources of our country even more. So although the unemployment hypochondriacs have little to fear in the near-term as the recovery continues, fiscal responsibility needs to be kept in check or hidden economic illnesses may become reality.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in BHP, POT, HPQ, PAR, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
In the midst of the so-called “Lost Decade,” pundits continue to talk about the death of “buy and hold” (B&H) investing. I guess it probably makes sense to define B&H first before discussing it, but like most amorphous financial concepts, there is no clear cut definition. According to some strict B&H interpreters, B&H means buy and hold forever (i.e., buy today and carry to your grave). For other more forgiving Wall Street lexicon analysts, B&H could mean a multi-year timeframe. However, with the advent of high frequency trading (HFT) and supercomputers, the speed of trading has only accelerated further to milliseconds, microseconds, and even nanoseconds. Pretty soon B&H will be considered buying a stock and holding it for a day! Average mutual fund turnover (holding periods) has already declined from about 6 years in the 1950s to about 11 months in the 2000s according to John Bogle.
Technology and the lower costs associated with trading advancements is obviously a key driver to shortened investment horizons, but even after these developments, professionals success in beating the market is less clear. Passive gurus Burton Malkiel and John Bogle have consistently asserted that 75% or more of professional money managers underperform benchmarks and passive investment vehicles (e.g., index funds and exchange traded funds).
This is not the first time that B&H has been held for dead. For example, BusinessWeek ran an article in August 1979 entitled The Death of Equities (see Magazine Cover article), which aimed to eradicate any stock market believers off the face of the planet. Sure enough, just a few years later, the market went on to advance on one of the greatest, if not the greatest, multi-decade bull market run in history. People repudiated themselves from B&H back then, and while B&H was in vogue during the 1980s and 1990s it is back to becoming the whipping boy today.
Excuse Me, But What About Bonds?
With all this talk about the demise of B&H and the rise of the HFT machines, I can’t help but wonder why B&H is dead in equities but alive and screaming in the bond market? Am I not mistaken, but has this not been the largest (or darn near largest) thirty year bull market in bonds? The Federal Funds Rate has gone from 20% in 1981 to 0% thirty years later. Not a bad period to buy and hold, but I’m going to go out on a limb and say the Fed Funds won’t go from 0% to a negative -20% over the next thirty years.
Better Looking Corpse
There’s no denying the fact that equities have been a lousy place to be for the last ten years, and I have no clue what stocks will do for the next twelve months, but what I do know is that stocks offer a completely different value proposition today. At the beginning of the 2000, the market P/E (Price Earnings) valued earnings at a 29x multiple with the 10-year Treasury Note trading with a yield of about 6%. Today, the market trades at 13.5 x’s 2010 earnings estimates (12x’s 2011) and the 10-Year is trading at a level less than half the 2000 rate (2.75% today). Maybe stocks go nowhere for a while, but it’s difficult to dispute now that equities are at least much more attractive (less ugly) than the prices ten years ago. If B&H is dead, at least the corpse is looking a little better now.
As is usually the case, most generalizations are too simplistic in making a point. So in fully reviewing B&H, perhaps it’s not a bad idea of clarifying the two core beliefs underpinning the diehard buy and holders:
1) Buying and holding stocks is only wise if you are buying and holding good stocks.
2) Buying and holding stocks is not wise if you are buying and holding bad stocks.
Even in the face of a disastrous market environment, here are a few stocks that have met B&H rule #1:
Maybe buy and hold is not dead after all? Certainly there have been plenty of stinking losing stocks to offset these winners. Regardless of the environment, if proper homework is completed, there is plenty of room to profitably resurrect stocks that are left for a buy and hold death by the so-called pundits.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and AAPL, AMZN, ARMH, and NFLX, but at the time of publishing SCM had no direct position in GGP, APKT, KRO, AKAM, FFIV, OPEN, RVBD, BIDU, PCLN, CRM, FLS, GMCR, HANS, BYI, SWN (*2,901% is correct %), CTSH, CMI, ISRG, ESRX, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.