Archive for November, 2011

Wall Street Meets Greed Street

For investors, the emotional pendulum swings back and forth between fear and greed. Wall Street and large financial institutions, however, are driven by one single mode…and that is greed. This is nothing new and has been going on for generations. Over the last few decades, cheap money, loose regulation, and a relatively healthy economy have given Wall Street and financial institutions free rein to take advantage of the system.

Not only did the financial industry explode, but the large got much larger. The FCIC (Financial Crisis Inquiry Commission), a government appointed commission, highlighted the following:

“By 2005, the 10 largest U.S. commercial banks held 55% of the industry’s assets, more than double the level held in 1990. On the eve of the crisis in 2006, financial sector profits constituted 27% of all corporate profits in the United States, up from 15% in 1980.”

 

What’s more, the obscene profits were achieved with obscene amounts of debt:

“From 1978 to 2007, the amount of debt held by the financial sector soared from $3 trillion to $36 trillion, more than doubling as a share of gross domestic product.”

 

Times have changed, and financial institutions have gone from victors to villains. Sluggish economic growth in developed countries and choking levels of debt have transitioned political policies from stimulus to austerity. This in turn has created social unrest. Who’s to blame for all of this? Well if you watch the evening news and Occupy Wall Street movement, it becomes very easy to blame Wall Street. Certainly, fat cat bankers deserve a portion of the blame. As one can see from the following list, over the last few years, the financial industry has paid for its sins with the help of a checkbook:

CLICK TO ENLARGE

The disgusting amount of inequitable excess is smeared across the whole industry in this tiny, partial list. Billions of dollars in penalties and disgorged assets isn’t insignificant, but besides Bernie Madoff and Raj Rajaratnam, very little time has been scheduled behind bars for the perpetrators.

Whom Else to Blame?

Are the greedy bankers and financial institution operators the only ones to blame? Without doubt, lack of government enforcement and adequate regulation, coupled with a complacent, debt-loving public, contributed to the creation of this financial crisis monster. When the economy was rolling along, there was no problem in turning a blind-eye to subversive activity. Now, the greed cannot be ignored.

At the end of the day, voters have to correct this ugly situation. The general public and Occupy Wall Street-ers need to boycott corrupt institutions and vote in politicians who will institute fair and productive regulations (NOT more regulations). Sure corporate financial lobbyists will try to tip the scales to their advantage, but a vote from a lobbyist attending a $10,000 black-tie dinner carries the same weight as a vote coming from a Occupy Wall Street-er paying $5 for a foot-long sandwich at Subway. As Thomas Jefferson stated, “A democracy is nothing more than mob rule, where fifty-one percent of the people may take away the rights of the other forty-nine.”

Investor Protocol

Besides boycotting greedy institutions and using the voting booth, what else should individuals do with their investments in this structurally flawed system? First of all, find independent firms with a fiduciary duty to act in your best interest, like an RIA firm (Registered Investment Advisor). Brokers, financial consultants, financial advisors, or whatever euphemism-of-the-day is being used for an investment product pusher, may not be evil, but their incentives typically are not aligned to protect and grow your financial future (see Fees, Exploitation, and Confusion   and Letter Shell Game).

There is a lot of blame to be spread around for the financial crisis, and the intersection of Wall Street and Greed Street is a major contributing factor. However, investors and voters need to wake up to the brutal realities of our structurally flawed system and take matters into their own hands. Only then can Main Street and Wall Street peacefully coexist.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

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 MS, UBS, C, JPM, WFC, SCHW, AMTD, BAC, GS, STT, Galleon, RBC, Subway, Amer Home, Brookside Captl, Morgan Keegan, 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.

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November 27, 2011 at 11:37 am 8 comments

The Rule of 20 Can Make You Plenty

There is an endless debate over whether the equity markets are overvalued or undervalued, and at some point the discussion eventually transitions to what the market’s appropriate P/E (Price-Earnings) level should be. There are several standard definitions used for P/Es, but typically a 12-month trailing earnings, 12-month forward earnings (using earnings forecasts), and multi-year average earnings (e.g., Shiller 10-year inflation adjusted P/E – see Foggy P/E Rearview Mirror) are used in the calculations. Don Hays at Hays Advisory (www.haysadvisory.com) provides an excellent 30+ year view of the historical P/E ratio on a forward basis (see chart below).

Blue Line: Forward PE - Red Line: Implied Equilibrium PE (Hays Advisory)

If you listen to Peter Lynch, investor extraordinaire, his “Rule of 20” states a market equilibrium P/E ratio should equal 20 minus the inflation rate. This rule would imply an equilibrium P/E ratio of approximately 18x times earnings when the current 2011 P/E multiple implies a value slightly above 11x times earnings. The bears may claim victory if the earnings denominator collapses, but if earnings, on the contrary, continue coming in better than expected, then the sun might break through the clouds in the form of significant price appreciation.

Just because prices have been chopped in half, doesn’t mean they can’t go lower. From 1966 – 1982 the Dow Jones Industrial index traded at around 800 and P/E multiples contracted to single digits. That rubber band eventually snapped and the index catapulted 17-fold from about 800 to almost 14,000 in 25 years. Even though equities have struggled at the start of this century, a few things have changed from the market lows of 30 years ago. For starters, we have not hit an inflation rate of 13% or a Federal Funds rate of 20% (~3.5% and 0% today, respectively), so we have some headroom before the single digit P/E apocalypse descends upon us.

Fed Model Implies Equity Throttle

Hays Advisory exhibits another key valuation measurement of the equity market (the so-called “Fed Model”), which compares the Treasury yield of the 10-year Note with the earnings yield of stocks  (see chart below).

Blue Line: 10-Yr Treasury - Red Line: Forward PE (Hays Advisory)

Regardless of your perspective, the divergence will eventually take care of it in one of three ways:

1.) Bond prices collapse, and Treasury yields spike up to catch up with equity yields.

2.) Forward earnings collapse (e.g., global recession/depression), and equity yields plummet down to the low Treasury yield levels.

AND/OR

3.) Stock prices catapult higher (lower earnings yield) to converge.

At the end of the day, money goes where it is treated best, and at least today, bonds are expected to  treat investors substantially worse than the unfaithful treatment of Demi Moore by Ashton Kutcher. The Super Committee may not have its act together, and Europe is a mess, but the significant earnings yield of the equity markets are factoring in a great deal of pessimism.

The holidays are rapidly approaching. If for some reason the auspice of gifts is looking scarce, then review the Fed Model and Rule of 20, these techniques may make you plenty.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

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.

November 20, 2011 at 3:01 pm 5 comments

Dominoes, Deleveraging, and Justin Bieber

Despite significant 2011 estimated corporate profit growth (+17% S&P 500) and a sharp rebound in the markets since early October (+18% since the lows), investors remain scared of their own shadows. Even with trembling trillions in cash on the sidelines, the Dow Jones Industrial Average is up +5.0% for the year (+11% in 2010), and that excludes dividends. Not too shabby, if you think about the trillions melting away to inflation in CDs, savings accounts, and cash. With capital panicking into 10-year Treasuries, hovering near record lows of 2%, it should be no surprise to anyone that fears of a Greek domino toppling Italy, the eurozone, and the global economy have sapped confidence and retarded economic growth.

Deleveraging is a painful process, and U.S. consumers and corporations have experienced this first hand since the financial crisis of 2008 gained a full head of steam. Sure, housing has not recovered, and many domestic banks continue to chew threw a slew of foreclosures and underwater loan modifications. However, our European friends are now going through the same joyful process with their banks that we went through in 2008-2009. Certainly, when it comes to the government arena, the U.S. has only just begun to scratch the deleveraging surface. Fortunately, we will get a fresh update of how we’re doing in this department, come November 23rd, when the Congressional “Super Committee” will update us on $1.2 trillion+ in expected 10-year debt reductions.

Death by Dominoes?

Is now the time to stock your cave with a survival kit, gun, and gold? I’m going to go out on a limb and say we may see some more volatility surrounding the European PIIGS debt hangover (Portugal/Italy/Ireland/Greece/Spain) before normality returns, but Greece defaulting and/or exiting the euro does not mean the world is coming to an end. At the end of the day, despite legal ambiguity, the ECB (European Central Bank) will come to the rescue and steal a page from Ben Bernanke’s quantitative easing printing press playbook (see European Deadbeat Cousin).

Greece isn’t the first country to be attacked by bond vigilantes who push  borrowing costs up or the first country to suffer an economic collapse. Memories are short, but it was not too long ago that a hedge fund on ice called Iceland experienced a massive economic collapse. It wasn’t pretty – Iceland’s three largest banks suffered $100 billion in losses (vs. a $13 billion GDP); Iceland’s stock market collapsed 95%; Iceland’s currency (krona) dropped 50% in a week. The country is already on the comeback trail. Currently, unemployment (@ 6.8%) in Iceland is significantly less than the U.S. (@ 9.0%), and Iceland’s economy is expanding +2.5%, with another +2.5% growth rate forecasted by the IMF (International Monetary Fund) in 2012.

Iceland used a formula of austerity and deleveraging, similar in some fashions to Ireland, which also has seen a dramatic -15% decrease in its sovereign debt borrowing costs (see chart below).

Source: Bloomberg.com

OK, sure, Iceland and Ireland are small potatoes (no pun intended), so how realistic is comparing these small countries’ problems to the massive $2.6 trillion in Italian sovereign debt that bearish investors expect to imminently implode? If these countries aren’t credibly large enough, then why not take a peek at Japan, which was the universe’s second largest economy in 1989. Since then, this South Pacific economic behemoth has experienced an unprecedented depression that has lasted longer than two decades, and seen the value of its stock market decline by -78% (from 38,916 to 8,514). Over that same timeframe, the U.S. economy has seen its economy grow from roughly $5.5 trillion to $15.2 trillion.

There’s no question in mind, if Greece exits the euro, financial markets will fall in the short-run, but if you believe the following…

1.) The world is NOT going to end.

2.) 2012 S&P profits are NOT declining to $65.

AND/OR

3.) Justin Bieber will NOT run and overtake Mitt Romney as the leading Republican candidate

…then I believe the financial markets are poised to move in a more constructive direction. Perhaps I am a bit too Pollyannaish, but as I decide if this is truly the case, I think I’ll go play a game of dominoes.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

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.

November 12, 2011 at 6:59 pm 1 comment

10 Ways to Destroy Your Portfolio

With the rise and frequency of heightened volatility in recent years, investing has never been as difficult as it is today. However, the importance of investing has never been more crucial either, thanks to the rising, corrosive effects of inflation, and the uncertainty surrounding the sustainability of Social Security, pensions, and other retirement accounts.

If you are not losing enough money from our structurally flawed and loosely regulated financial industry that is inundated with conflicts of interest, here are 10 additional ways to destroy your investment portfolio:

#1. Watch and React to Sensationalist News Stories: Typically, strategists and pundits do a wonderful job of parroting the consensus du jour. With the advent of the internet, and 24/7 news cycles, it is difficult to not get caught up in the daily vicissitudes. However, the accuracy of the so-called media experts is no better than weather forecasters’ accuracy in predicting the weather three Saturdays from now at 10:23 a.m. Investors would be better served by listening to and learning from successful, seasoned veterans (see Investing Caffeine Profiles).

#2. Invest for the Short-Term and Attempt Market Timing: Investing is a marathon, and not a sprint, yet countless investors have the arrogance to believe they can time the market. A few get lucky and time the proper entry point, but the same investors often fail to time the appropriate exit point. The process works similarly in reverse, which hammers home the idea that you can be 200% wrong when you are constantly switching your portfolio positions.

#3. Blindly Invest Without Knowing Fees: Like a dripping faucet, fees, transaction costs, taxes, and other charges may not be noticeable in the short-run, but combined, these portfolio expenses can be devastating in the long-run. Whether you or your broker/advisor knowingly or unknowingly is churning your account, the practice should be immediately halted. Passive investment products and strategies like ETFs (Exchange Traded Funds), index funds, and low turnover (long time horizon / tax-efficient) investing strategies are the way to go for investors.

#4. Use Technical Analysis as a Primary Strategy: Warren Buffett openly recognizes the problem with technical analysis as evidenced by his statement, “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.” Legendary fund manager Peter Lynch adds, “Charts are great for predicting the past.” Most indicators are about as helpful as astrology, but in rare instances some facets can serve as a useful device (like a Lob Wedge in golf).

#5. Panic-Sell out of Fear & Panic-Buy out of Greed: Emotions can devastate portfolio returns when investors’ trading activity follows the herd in good times and bad. As the old saying goes, “The herd is lead to the slaughterhouse.” Gary Helms rightly identifies the role that overconfidence plays when ininvesting when he states,”If you have a great thought and write it down, it will look stupid 10 hours later.” The best investment returns are earned by traveling down the less followed path. Or as Rob Arnott describes, “In investing, what is comfortable is rarely profitable.” Get a broad range of opinions and continually test your investment thesis to make sure peer pressure is not driving key investment decisions.

#6. Ignore Valuation and Yield: Valuation is like good pitching in baseball…very important. Successful investors think about valuation similarly to skilled sports handicappers. Steven Crist summed it up beautifully when he said, “There are no ‘good’ or ‘bad’ horses, just correctly or incorrectly priced ones.” The same principle applies to investments. Dividends and yields should not be overlooked – these elements are an essential part of an investor’s long-run total return.

#7. Buy and Forget: “Buy-and-hold” is good for stocks that go up in price, and bad for stocks that go flat or decline in value. Wow, how deeply profound. As I have written in the past, there are always reasons of why you should not invest for the long-term and instead sell your position, such as: 1) new competition; 2) cost pressures; 3) slowing growth; 4) management change; 5) excessive valuation; 6) change in industry regulation; 7) slowing economy; 8 ) loss of market share; 9) product obsolescence; 10) etc, etc, etc. You get the idea.

#8. Over-Concentrate Your Portfolio: If you own a top-heavy portfolio with large weightings, sleeping at night can be challenging, and also force average investors to make bad decisions at the wrong times (i.e., buy high and sell low). While over-concentration can be risky, over-diversification can eat away at performance as well – owning a 100 different mutual funds is costly and inefficient.

#9. Stuff Money Under Your Mattress: With interest rates at the lowest levels in more than half a century, stuffing money under the mattress in the form of CDs (Certificates of Deposit), money market accounts, and low-yielding Treasuries that are earning next to nothing is counter-productive for many investors. Compounding this problem is inflation, a silent killer that will quietly disintegrate your hard earned investment portfolio. In other words, a penny saved inefficiently will depreciate rapidly.

#10. Forget Your Mistakes: Investing is a very challenging game, and it is not getting any easier. As Albert Einstein said, “Insanity is doing the same thing, over and over again, but expecting different results.” Mistakes will be made and it behooves investors to document them and learn from them. Brushing your mistakes under the carpet may make you temporarily feel better emotionally, but does nothing to help your returns.

As the year approaches a close, do yourself a favor and evaluate whether you are committing any of these damaging habits. Investing is tough enough already, without adding further ways of destroying your portfolio.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

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.

November 5, 2011 at 10:36 pm 11 comments


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