Zandi's 4 Worries About the U.S. Economy

Mark Zandi, chief economist at Moody's Analytics and author of "Financial Shock," is positive on the U.S. economy through the end of 2011 but cites 4 worries : falling home prices, inflation in China, continuing European debt problems, and State and Local government finances.

Of course, another one can be added at this point:  oil price shock and a global economic impact from unrest in the Middle East.

It seems to me that the housing market is more important to the economic recovery than is generally realized. The building of houses can't be outsourced overseas, and carpenters don't need a college education. One of our national past times is whining over the lost ability in America to get a good job, put two cars in the garage, and raise a family without having to get a college education.

Well, home building is an area where this possibility still exists. I guess it would be cynical to suggest that policy wonks understand this well and looked the other way as mortgages were made to those who couldn't afford them several years ago - all for the sake of short-term economic growth.

In terms of Zandi's list, the China inflation issue is the most worrisome to me. The others, I believe, can be muddled through. The inflation issue, however, could cause a global slowdown if China steps on the brakes too hard. A fact of economic life that is gradually dawning on us is that we now live in a world where we are greatly affected by another rising economic super power.

3 Quotes to Understand

When I give presentations, and even when I talk with potential clients, I like to start off with quotes. The reason is simple. Numbers and graphs can easily be manipulated. I learned this years ago when I picked up a copy of "How to Lie With Statistics" by Huff. Instead of the numbers, I like to start by bringing  the experienced, wise people right to the table and discussion.

Warren Buffett: "Most investors, both institutional and individual, will find the best way to own common stocks is through an index fund that charges minimal fees.  Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals."

Notice that he is talking about institutions as well as individuals. He is not just talking about you and me using index funds; he is also talking about the huge state pension funds like CALPERS and the state of New York fund, the large union funds, and so forth. Think about this:  these funds have staffs comprised of Harvard and Wharton Business School graduates. They are paid big bucks. And Buffett is saying that still these institutions should use index funds. And they do!

I don't know about you, but this tells me a lot.

Benjamin Graham, coauthor of Security Analysis : "If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what's going to happen to the stock market."

The first thing that jumps out here is the "...60 years..." This is a lot of years watching the stock market. Appreciate that Security Analysis is considered a bible by value stock investors, and Graham himself was Buffett's mentor. His statement boils down to this:  if your advisor is trotting out all kinds of fancy charts and talking about getting into and out of the market on the basis of an economic forecast, he/she will not likely earn better than the market return. Graham doesn't say it, but you can take this to the bank:  they will charge you a lot for making the attempt and leave you with a smaller nest egg in the bargain.

Jack Meyer, head of Harvard University's endowment fund: "The investment business is a giant scam.  Most people think they can find fund managers who can outperform, but most people are wrong.  You should simply hold index funds. No doubt about it."

Meyer doesn't mince words. He is heading up one of the institutions Buffett was talking about. Imagine the investment managers who have made presentations about their investment approach to him over the years. Why is the business a scam? Simply, it over-promises and under-delivers.

Howard County's 2nd Annual "Passport to Financial Literacy"

This Saturday at Howard Community College "makingCHANGE," a local non-profit financial education organization, is presenting a free financial literacy event. RW Investment Strategies is a sponsor, and I will be manning one of the 20 stations that young people will stop at. Each station is a financial decision point. What kind of occupation will you pursue? How much will it pay? How will you afford transportation? How much do different kinds of cars cost? How do you finance? How much does a college education cost? How much does a house cost? What is a mortgage and what does the monthly payment amount to? As the children go through the stations, they have a passport that will be stamped. One lucky child will win a laptop!

Imagine the pain the country could have avoided if everybody had examined the last question several years ago!

There is a lot of talk about increasing financial literacy. This is an event that actually does something about it. I hope to see you there!

Middle East in Turmoil - What Should Investors Do?

Source:Guardian.co.uk

"The country has gone to ruin,” Mona Abdelaziz, 30, who said that she holds a journalism degree and works selling tissues by the roadside, said in an interview yesterday at a protest in central Cairo. “Everything is expensive. How will my son marry, get an education, set up a household? There are no jobs, only for a select few. We have no hope.” 

Perhaps the smartest man I ever knew once told me there is only one economic principle - "people want to earn a good wage."   This plays out over time on a global basis. Most people are content to have the opportunity to raise their family in a setting where they are treated with respect. This, of course, bumps up against the small percentage of those who are power hungry and somehow feel they are entitled to live above the laws and economic circumstances that govern most of the world.

Egypt,, of course is a special problem for the U.S. because, once again, the U.S. finds itself on the wrong side. It says one thing and does another. And the world understands this. We continue to prostitute ourselves for oil.

What about investments? How is this going to turn out? How to respond to the quantum jump in uncertainty? Is this a Taleb  Black Swan? Is this Thanksgiving day for Taleb's turkey?

The answer is nobody knows. The violence could spread, thereby putting further pressure on oil prices and markets. At this point, this seems the likely course. Market observers remember well the East Asian contagion of 1997.

Or, Mubarak could step aside and someone of intelligence gain control and markets rally. Not likely, but possible.

As a DIY investor, you have an advantage over most investors. You have a thought-out asset allocation plan. You understand that markets are choppy and that the consistent rise over the past several weeks is temporary. You know your exact asset allocation. You understand you are in one of two boats - you are either in the accumulation phase or the decumulation phase. You are either building up your nest egg or you are drawing a paycheck off of it.


You've anchored your asset allocation  to your age. If you are 65 years old, you started at 65% bonds and added bonds, if you are risk averse, or reduced the percentage in bonds, if you are a risk taker. You understand that, if the events in the Middle East are keeping you up all night, you need to increase your exposure in fixed income. You saw the value of bonds on Friday in protecting portfolio assets. AGG, the Barclay's aggregate bond index exchange traded fund (ETF), rose .15% as the S&P 500 fell 1.79%. CSJ, a shorter maturity corporate bond ETF, rose .01%.

For the retiree, this is a point where the percentage in bonds could be increased by 5% to add a bit more protection in case this market continues South. Even with Friday's large drop, the S&P 500 is up for the year.

But what about the accumulator? You see the present situation a bit differently. You are alert to a possible opportunity to pick up equities at lower prices. You are poised to take advantage of  "dollar cost averaging" - the buying of more shares with a given amount of money at lower share prices. You are monitoring the market developments with an eye towards possibly increasing the allocation to your 401k, especially if you are more than 5 years away from retirement. Like the retiree, though, you are constantly taking your pulse. If it is racing, hold off on increasing exposure and maybe even reduce equity exposure a small amount.

The fact of the matter is that no one knows where we go from here. The global economy was in an uptrend before the riots in Tunisia started. Investors were slowly gaining confidence after the debacle in 2008. Now confidence has again been shaken. We know that the Great Recession weighs heavily on investors' minds. The important point to remember is that drastic portfolio shifts in these types of situations are typically harmful. Taking a small step to reduce volatility at the beginning of a potential downturn can be a useful calming step.

Disclosure:  This post is for educational purposes only. Individuals should do their own research and consult their advisors before making investment decisions.

What is GDP?

To do a poor man's overview of the macroeconomy, you need to know 3 things:  GDP, inflation, and the unemployment rate. With a nice tie and the ability to riff on these 3 magnitudes, you are ready for a stint on CNBC. Throw in a couple remarks about foreign exchange, especially the Yuan, and they might offer you a guest commentator spot.

But what exactly is GDP (if you're a former student of mine I hope you don't need to keep reading), and why do markets care?

Incidentally, the advance estimate of 4th quarter GDP is released today at 8:30 am. There are two revisions to the advance estimate based on more complete data released at a later date. To find out what economists expect (you should know this if you're headed for the CNBC studios), go to the Bloomberg calendar. There you find that real GDP (GDP after taking out the impact of inflation) is expected to increase 3.5%, and the inflation measure derived from the data (called the GDP deflator) is expected to show an increase of 1.5%.

GDP Source:Bloomberg

CLICK TO ENLARGE

Scroll down at the Bloomberg site and you'll see a graphical presentation of both of these magnitudes, useful for gaining a longer term perspective. The graph shows the "Great Recession" as a sharp dip and then the sharp spike off the bottom that economists are talking about today--and that stock market investors are cheering on.

So what exactly does GDP measure?  By definition, it is the market value of all final goods and services produced within a country over a given period of time. The reason we look at "final goods and services" is to avoid what is called double counting. When you buy a car, the value of the car includes what the car company paid for the tires, sound system etc. To count these separately, and then the value of the car, would include their values twice.

Notice that the focus is on the rate of growth and not the magnitude. For those who need to know, GDP totals approximately $15 trillion. To gain some perspective, it takes a bit over 31 years to reach a billion seconds and 1 trillion is 1,000 billion. To look at GDP from another perspective, it would $15 trillion to buy all the goods and services produced in the U.S. over a 12-month period. That's some big bucks - even to the likes of Warren Buffett and Bill Gates.

In interpreting the growth rate of real GDP (which is the important magnitude), there is a sort "Goldilocks" thing going on - you don't want it too hot or too cold. If the growth rate goes above 5%, say, for a protracted period, people worry about inflation. At much less than 3.5%, the worry is deflation and a possible recession and the loss of jobs. Because the U.S. is job challenged at the moment, the higher the better for the GDP growth rate!

How to Calculate Time Weighted Return

Bowser in the Snow

DIY investors need to know how their investments are performing. Many don't. I know because I ask. And when I do, many times, I get a non-comprehending look back. Some of you know that I get on the soap box from time-to-time and rant and rail about knowing investment performance. Too many times I've seen people say their advisor is doing great because he or she made him x number of dollars in the last 3 months. It seems to be news to some people that making 6% when the market or benchmark makes 8% is actually not a good thing. I know it's percentages, and I know percentages are about the point where a goodly percentage (see can't get away from it!) of the population started to hate math; but it is important to deal with them  to assess performance.

Over decades, a small under-performance can subtract a lot  from a portfolio.

Thankfully,  the portfolio calculation is getting easier by the minute. The technology that does all the work is spreading. In fact, a recent post on Schwab's Performance Calculator described how easy it is to get performance for both portfolios and benchmarks at their site.

Still, as a member in good standing of the "although I can multiple 2 numbers using a calculator it is still worth knowing how to do without a calculator" fraternity, I think those investors not totally allergic to math should know how to calculate performance. Again, with today's technology this is easy.

To begin, pick out the accounts you need to do the calculation for. This is easy on most discount brokerage sites. For example, if you have 5 accounts (2 brokerage accounts, a Roth IRA, and 2 traditional IRAs) and you just want to track performance for the IRAs, you can set up a grouping for these 3 accounts and call it "IRAs" or even "My IRAs"(pretty clever naming, huh?). If you want, of course, you can do the calculation for all accounts.

If there are no additions or withdrawals to the accounts, all  we need to do is divide the ending portfolio value by the beginning value. For example, if the accounts totaled $1,000 and now are at $1,200, we've made 20%--we're doing great!

Actually not so fast - hold the smiley face. If the benchmark (passive portfolio we are comparing ourselves against that is typically made up of market indices) is up 30%, we actually haven't done that great.

But what about cash in and cash out? Maybe we deposited $200 into one of the IRAs! This is where the concept of time-weighted return (TWR) comes into play. The trick is to calculate return to the point before the deposit and then calculate return starting from the point after the deposit and multiply them. This is called linking. This approach measures how the investment performed and is independent of the cash flows.


Some Math

Let's look at a simple example:

Start with $1000 and assume it grows to $1150, at which point you put in $300 and it grows to $1725. What is your TWR?  Easy:
1150/1000 = 1.15
1725/1450 (we've added the 300 deposit to the 1150) = 1.19.
Multiply and get 1.3685 and the TWR is 36.85%.

To go one step further, suppose this was over a 2-year period. Then you may want to convert to an average annualized return. This is easy:  just take the .5 root of 1.3685 and get 1.169. Thus, on  an average annualized basis, you made 16.9%.

A little bit of thought reveals that some care needs to be taken when looking at TWR. Suppose you start with $1,000 and it increases to $1,200, at which point a deposit of $10,000 is made and at the end of the period the portfolio is $11,200. You made a 20% return on the smaller amount and a 0% return once the $10,000 was in the account. 

For my clients, I handle all of this very simply. I get daily valuations of portfolios. This actually only takes a few minutes a day. Then at the end of the month, I look at the history of the accounts (again only a few minutes); and if there are withdrawals or additions, I make the adjustments. If the client is with Schwab, of course, I don't have to worry about any of this.

Want to be Warren Buffett But Too Lazy?

Not that many years ago, it seemed that every kid on the basketball court wanted to be Michael Jordan. They worked hard, in their imagination, at recreating his game-winning shots. But, as many basketball coaches/motivators were fond of pointing out, not one-in-a million were willing to do what it takes to be a Michael Jordan. His work ethic in the weight room and at practices was legendary. At practice, he insisted that the best defender on the team (Scottie Pippen) be on the side that he was scrimmaging against. He always wanted to go against the best.




In the same way in the investment field, there are many who want to be the next Warren Buffett. But how many are willing to do what it takes to be a Warren Buffett? Buffett talked his way into Columbia Business School to study under the legendary Benjamin Graham. Classmates said he knew Graham and Dodd's "Security Analysis" classic better than the authors did. Question:  How many are willing to do what it takes to be Warren Buffett? How many of you know the text better than the authors?

Since I don't see any hands up, consider an easier approach - sort of the video game version, I guess, of recreating a Michael Jordan game winner.

According to Russel Kinnel, Morningstar's Director of Mutual Fund Research, as listed on page 59 in "FundSpy," the following funds  are "Buffet followers:"  the Sequoia fund (SEQUX), Fairholme Fund (FAIRX), Dreyfus Appreciation(DGAGX), Oakmark (OAKMX). Returns over the past 5 years on these funds have ranged from 3.36% to 9.08%. Interestingly, the fund with the highest turnover (71%) (I know...don't ask me how a "Buffett follower" would have a 71% turnover rate)  had the highest return.

Kinnel points out that, as many do, you can always buy Berkshire Hathaway shares.

All of this is out of my "there is more than one way to skin a cat" file. I am a proponent of low-cost index funds as the way to invest for DIY investors for at least 80% of their  retirement funds. The easiest thing in the world is to pick out past winners. As a point of fact, Buffett himself has said,

"Most investors, both institutional and individual, will find the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals."

Disclosure:  I hold none of the funds mentioned here and do not endorse or recommend them. The information is solely for educational purposes. Individuals should do their own research or consult an advisor before making investment decisions.