We Know What to Do - Let's Do It!

Isn't it striking how every politician in Washington DC can eloquently riff on what is wrong with the U.S. political system and yet the system continues in a highly dysfunctional state?  This points up the well-known and frustrating fact that people know what to do to take steps to regain functionality but the will is lacking.  Sort of like dealing with an accident-prone teenager walking around with a cell phone glued to his ear.

Thomas Friedman (of whom I'm not especially a big fan) bluntly makes some recommendations on banking in "Did You Hear the One About the Bankers?":

1) If a bank is too big to fail, it is too big and needs to be broken up. We can’t risk another trillion-dollar bailout. 2) If your bank’s deposits are federally insured by U.S. taxpayers, you can’t do any proprietary trading with those deposits — period. 3) Derivatives have to be traded on transparent exchanges where we can see if another A.I.G. is building up enormous risk. 4) Finally, an idea from the blogosphere: U.S. congressmen should have to dress like Nascar drivers and wear the logos of all the banks, investment banks, insurance companies and real estate firms that they’re taking money from.

These are basic recommendations.  OK, maybe #4 is a bit extreme - but that's the blogosphere:).  Still, you don't need a PhD to grasp the thrust of Friedman's recommendations, but that's the case for most sensible policy.  For example, it doesn't take an Einstein to understand that there should be a law that you can't buy a house without at least a 15% down payment - period.  But nobody stood up and said the crazy mortgages leading up to the housing crisis were the stuff of a global meltdown.  In fact, one theory says that those outside of politics who recognize the ramifications exploit them by their trading prowess. This was evidenced by the fortunes made by those who analyzed mortgage data and shorted securities bogusly rated AAA when they were comprised of obvious (except I guess to the rating agencies) toxic debt.

But it is also the case that sensible policy many times pulls the gravy bowl away from special interests who profit at the expense of the public.  I believe the "Occupy Wall Street" movement and the Herman Cain ascendency are telling politicians they better get this if they want to get elected.  In fact, we may have reached the point where those in power need to step on some "third rails".

Italian Bond Yields

Source: Capital Pixel

So Europe pulled it off!  They agreed on haircut for Greek debt, percent of debt to GDP, bolstering Tier 1 capital position for banks, and funding for EFSF.  I echo those who wonder if the U.S. government can learn something here.

Now it's about execution, and a key indicator will be Italian bond yields - in particular the 10-year Italian bond yield.  To the extent that its level (5.91%) comes down and especially its spread ( +3.50%) to the 10-year German Bund narrows, it is an indication that pressures are easing.  In particular, it indicates a lessening in the probability of contagion - the spreading of the crisis throughout the region.  Another way to say this is:  it indicates the EFSF is sufficient.  A spreading of the crisis to Italy, etc. could not be handled by a $1 trillion EFSF.

The German Bund is, of course, a benchmark throughout Europe given the strict monetary policy the German central bank followed after the country's episode with hyperinflation during the 1930s. 

Following European Bond Yields

One of the really good sources for following the yield on the Italian 10-year bond, along with other European yields, is the Financial Times financial data site:

Source:  Financial Times

 CLICK IMAGE TO ENLARGE 








This chart from The Economist provides a longer term perspective and shows what happened to Greek debt as the crisis unfolded:

Source:  The Economist 10/27/2011

CLICK IMAGE TO ENLARGE As an aside, I highly recommend picking up from time to time both of the publications mentioned here.  You'll come to understand how U.S. centric the views are that are reported and editorialized on by the U.S. press - the rest of the world sees many events from a completely different perspective.

The Best Investment - Revisited

Source: durtcom

In August, I wrote a post about rear view mirror investing. At the time, investors were piling into bonds and precious metals and didn't like stocks.  I cited the following year-to-date returns at the time:

TLT (longer term U.S. Treasury exchange traded fund): +20.79%
GLD (gold exchange traded fund): +29.02%
INTC (intel common stock):  -6.03%

Back then, the 10-year Treasury note yield was 2.07%, the S&P 500 stood at  1123.53, and gold was $1,848/oz..

Today the yield on the 10-year Treasury note is 2.26%, the S&P 500 stands at 1254.19, and gold is priced at $1661.50/oz.

The returns on the aforementioned ETFs and Intel common stock since the August post have been:

TLT = 3.05% (helped by a drop in the yield on the 30-year bond from 3.39% to 3.27%)
GLD = -10.5% ( no dividends - ouch!!!!!)
INTC = +28.1% (this is without the dividend to be paid in November).

These particular investments are obviously very different with their associated risks and returns.  The return on most precious metals is driven by the fear factor.  Investing in precious metals when fear is running very high introduces the possibility of buying close to a peak.  The investor needs, in this instance, for fear to be maintained at a high level or even to ramp up.  As is well known, there is no dividend here - the investor is relying on a future buyer denanding the metal at a higher price.  There's no guard rail on the trampoline.

Also driven by fear, especially in today's markets, is the U.S. Treasury market - still considered the safest in the world despite downgrades and potential downgrades.  Investors continue piling into an issue that pays roughly 2% for the next 10 years.  At today's inflation rate, this is a negative real return.  With the global investment community on its knees begging Germany to print money, it is scary to contemplate where inflation could go several years down the road. 

Intel, on the other hand, pays a dividend yield of 3.50% which has the potential to increase over the next 10 years and has had exceptional earnings fueled by the apparently insatiable global demand for electronics products.  Investing in any single stock is risky, of course, and Intel is used here only as an example.

The bottom line is that rear view mirror investing, i.e. chasing the hot sector, can be costly.  Sometimes valuations get out of whack.  Perhaps a useful question is how wide would the spread have to be between the 10-year Treasury note and a particular dividend yielding stock to make the swap?

Disclosure:  I own Intel stock.  The purpose of this post is for educational purposes.  Investors should do their own research and consult with an advisor before investing.

Largest Employer of Certified Financial Planners Sued

In late September, six people, including a current employee, sued Ameriprise Financial on issues related to its 401(k) plan, as described by Lieber in "Financial Planner's Red Flags."  There are several ongoing suits against 401(k) plans on the basis of cost and performance results.  This, to my knowledge, is the first suit brought against a financial services firm by its employees - those who sold its products!

Sadly, this occurs despite the voluminous evidence that actively-managed funds underperform over the longer term after fees. By choosing actively-managed, highly touted funds that have had superior performance in the past, participants are playing what Charles Ellis refers to, in the Wall Street Classic,  as "The Loser's Game."

In the Ameriprise suit, the plaintiffs argue that the plan is "stuffed" with high-cost, poor-performing funds managed by the company.  Lieber's piece details some of Ameriprises' history that gets me to wonder why, frankly, people do business with them.  But, then again, this is true of many of our largest financial services organizations.  They participate in every sleazy financial event that comes along from doing illegal barge, earnings manipulating, buybacks with the likes of Enron to pushing inappropriate derivatives on unsophisticated municipalities.  And yet people trust them with their money!

I understand that there are always a few bad apples in a large organization, especially when compensation is determined by product sold and there are huge incentives to put clients in inappropriate investments.  This is not what this is about.  It is about the culture of these companies.  They exploit the lack of knowledge of consumers and, in the end, create problems for the country by putting people's retirement at risk.

The article points out:

It has to be frustrating for Ameriprise to see its menu of mutual funds splayed out for all of the world to see, complete with details on poor performance and a handy chart showing fees that are three to five times what they are at Vanguard.

I, for one, have no sympathy.  Thankfully, fee disclosure is on the way next year for all 401(k) providers.

Along with many others, I recommend individuals do considerable research and at least compare the approach of fee-only, independent advisors.

Are You a Democrat or a Republican?

I, along with millions of Americans, watched the Republican candidates debate last night.  Really, what better entertainment is there?  Actually, "Dancing With the Stars" is pretty close; and I did do a lot of switching back and forth.

Anyways, it got me to thinking of the difference between the parties and what makes one a Democrat or a Republican.  I have to admit that I've switched parties and may switch again, but I'm getting so confused that I'm not sure which primary I'm supposed to vote in.  I guess I should make my life easier and just register as an Independent.

My difficulty is that candidates don't stick to their supposed convictions.  Frankly, the basic principles of the parties are well specified; and, on that basis, my choice is clear.  I believe, for most Americans, I can watch their behavior and pretty well guess their political leanings.  Here's the simple test.

Suppose you have a 2-year-old, and he or she climbs on a chair (as they like to do) and falls off the chair (as they inevitably do) and is sprawled on the floor bawling.

Watch closely the parent.  Some will swoop Junior up, shower him/her with kisses, and hit the "nasty chair."  They will explain to teary Junior in excruciating detail that the chair is "bad, bad, bad!"

Watch me.  There is a bemused look on my face.  Someone asks if I'm not going over to help the kid?  I respond that he/she climbed on the chair and fell off.  Let the kid cry and think about what happened.  Maybe the kid will think about it the next time he/she climbs on a chair.  Maybe the kid will come to realize that doing something stupid isn't a way to get attention.

My thinking is that the kid is learning a valuable lesson there on the floor.  One day I won't be here and my wife won't be here to rescue the kid when he/she screws up.  The kid will learn early on that he/she has a certain amount of responsibility.  It is interesting to watch a child all of a sudden stop bawling once he or she realizes no one is paying attention.  Sort of like people miraculously getting a job right after unemployment benefits run out.

By now, most of you have figured my political leanings and probably, with a little thought, can understand why I switch parties.

I'm not arguing right or wrong.  In fact, I believe there is a need for both views - although the extreme coddling is highly dysfunctional, IMHO, as is the view to never offer help - but then that gets us towards the middle of the political spectrum.  I'll admit it isn't easy watching a child learn a lesson sometimes.

I will say, however, that allowing the kids to deal with their own misjudgements has worked.  You never saw my children screaming at the top of their lungs in a grocery store because they couldn't have candy or cookies or a certain cereal.  There was never the the need to call Super Nanny - which, by the way, Cooper Anderson could have used last night.

Performance Report

How are your investments doing? This is a fairly common question these days with Europe dealing with bailout problems, the U.S. worried about a recession, and politicians acting stupider than usual.  Some put all this together and opt for money market accounts.  Unfortunately for many, that won't get the retirement many want.

On a number of occassions, I've posted about asset allocation and how to set up a well-diversified portfolio of exchange traded low-cost funds.  I've touted the performance capabilities of Schwab that enables investors to track their performance on an ongoing basis.

Returning to the question above, the fact is that most investors don't know their performance.  I know because I ask them.  I could probably put together a pretty entertaining comedy tape from the answers I get. The bottom line is that many wait for an advisor's report that arrives weeks after the end of a quarter.  Then even with all the negative news going around, they are afraid to open the report.

Here is a Schwab client performance report through the close of the market yesterday:

Source: Charles Schwab

CLICK TO ENLARGE  This client happens to be in the "Moderately Conservative" model which is basically 40% equities/60% fixed and cash. Note that the return since inception is within .12% of the benchmark (shown as the footnote)  - basically the cost of the fund's ETFs.  This report combines 3 accounts:  taxable, traditional IRA, and Roth IRA.

Although the return is modest at 4.62%, it is considerably better than the return many seniors have achieved on CDs, etc.; and it is at relatively low risk.

Managing risk, of course, is a key element of this process.  At the beginning, client and advisor need to assess risk tolerance because a key is to be comfortable holding the portfolio through ups and downs.

Disclosure:  Past returns are no guarantee of future returns.  Individuals should consult an advisor and/or do their own research before investing.  I am not affiliated with Schwab.  This post is solely for educational purposes.

Bulls, Bears, and Black Swans

"Those who do not learn from history are doomed to repeat it." - George Santayana

Mention black swans and you get investors' attention.  These are the rare events that destroy portfolios.  Unfortunately, they are not as rare as commonly thought.  Two have occurred in the last 10 years - the dot.com bust and the housing crisis.  The term, of course, was popularized by hedge fund trader Nassim Taleb in what was said to be the most widely read book on Wall Street a few years ago - The Black Swan.  The book is a must-read for DIY investors.  It is one of those books where you'll feel smarter after you've read it.

In another must-read, The Investor's Manifesto, William Bernstein says, "...the only black swans are the history that investors have not read."  This is his way of saying that extreme financial events won't be a surprise to those who know their financial history.  Bernstein cites the Great Depression during which stocks lost 90% of their value.  Interestingly, Taleb's investment approach is to stay highly liquid, hide in the bushes, and be ready to pounce when the black swan arrives.  It's an approach that has worked for him.

Bernstein uses this background to support his point that using historical returns can be costly.  In essence, it is looking in the rear view mirror - something investors do naturally.  An example he uses is highly relevant to today and worth thinking about for the DIY investor, especially those piling into bonds today.

From 1952 - 1981, long-term Treasury bonds had an average annualized return of 2.33% as inflation averaged 4.31%.  In other words, they had a negative real return over the period.  Over the same time frame, the S&P 500 returned 9.89%.  Bonds were referred to as "certificates of confiscation."

At the Treasury auction of 9/30/81, 20-year Treasury bonds were auctioned to yield 15.78%.  Over the 5 years up to that point, inflation averaged 10.11%!  As I recall, this was the weakest auction in terms of bidding interest in the history of the U.S. Treasury - this despite a "real" return in excess of 5%!  At the time Fed Chairman Volcker had already tightened money drammatically.  Over the ensuing 5 years, inflation dropped to 3.42%.

Over the 20 years following this auction, the real return (after inflation) on the long-term Treasury bond was 8.66%.

Today we find ourselves at the other end of the spectrum.  Recently the yield on the 10-year Treasury note dropped below 2%, producing exceptional returns in an environment where inflation has been anemic.  Inflation, however, is showing signs of perking up and is well above 2%.  The Federal Reserve, furthermore, has aggressively expanded their balance sheet by monetizing the debt aggressively with their various "quantitative easing" programs.  Banks are flush with excess reserves that could see a dramatic flooding of the economy with money over the next several years, thereby further fueling the inflation that Chairman Bernanke so desperately seeks.

But investors are looking in the rear view mirror and sopping up Treasury notes at every auction. Beware the black swan.

My Problem With Morgan Stanley

Going through old financial statements can be a depressing experience for financial advisors - not so much because of what individuals investors did, but because of what was done to them.

This from a 9/06/2006 presentation by Morgan Stanley reps on a SIMPLE IRA:

What is Asset Allocation?

     i. Avoids The Big Mistake
       From 1984 to 2002, S&P 500 - 12.22% annually ( penciled in by employee "-Market")
       Versus Average Equity Fund Investor - 2.57% ( penciled in by employee "-People")
       Versus Yale Endowment - 17.4% ( penciled in by employee "Professionals")

The presentation was made to young professionals.  The young lady whose statements I was reviewing was 23 years old and had less than $10,000 in her account.  She is very skilled in graphic arts but not so much in investing.  She doesn't know the questions to ask.  She didn't know to raise her hand and ask if the Yale Endowment performance was representative of professional asset allocation in general and Morgan Stanley's funds in particular.  She didn't know the difference between load and no load or the different classes of funds.  She would have looked at you blankly if you mentioned a 12B-1 fee.

You can imagine the thinking so carefully crafted by the Morgan Stanley reps as they went through their presentation.  It was basically proven to her that people do poorly and  professionals as represented by Yale's fund hit the ball in the upper deck.  This of course is a lie.  Professionals, on average, underperform over long periods after costs are included.

It's not clear whether she chose the fund or the Morgan Stanley advisor chose the fund, but she ended up with 100% of her small account going into Evergreen Asset Allocation A.  The fund had a front load of 5.5% and an expense ratio in excess of 1%.

Once again, we have to wonder how Morgan Stanley et al. of their ilk sleeps at night.  I'm sure some reps say "very well, thank you" every time they go to the bank.  Some are probably even looking out their windows right now and wondering about the protests taking place in the streets.

Unemployment

Today the market is braced for the release of the monthly employment data.  It is released on the first Friday of each month at 8:30 am.  To find out when data is released, you need a calendar of economic events, like the following, available at ECONOMIC CALENDAR.

Source: ECONODAY

By clicking the indicated link, you'll find that economists expect the unemployment rate to tick up to 9.2% and the number of jobs gained to be reported at 65,000.

For a discussion before the number and an interpretation after the release, tune in to CNBC around 8:20 am. Typically there are a few economists and other pundits discussing the number. As you know, the employment situation is a key to whether Obama is re-elected or not.  If 14 million Americans are still out of work next year this time, the President will have tough going.

Rather than rely so much on others' interpretation, I prefer to go directly to the actual data which can be found at EMPLOYMENT REPORT.

CLICK TABLE TO ENLARGE As you can see, there is a lot of data not typically reported in the press--including the report for various sub populations as well as the rate of unemployment by education level.  The Bureau of Labor Statistics does an excellent job at presenting all kinds of data and answering questions on the reports they issue.

Finally, to get an historical perspective, it is worthwhile looking at a graph going back to 1970:


This UNEMPLOYMENT RATE GRAPH is easy to make.  If you want details, just send me an email.  The graph shows that the U.S. economy has experienced 7 recessions since 1970, with the most recent one being the longest and most painful - taking the rate of employment from below 5% to up over 9% where it is stubbornly stuck.  An important point to note is that the rate is not falling as it typically does after the end of a recession.  This, in a nutshell, is one of the major economic issues facing the country.

As an historical note, you can see that the rate dropped below 4% in 2000.  Before that, economists predicted a pick up in inflation at such a low rate.  It didn't occur!

Steve Jobs

A Standford University commencement address by Steve Jobs worth viewing - from "The Biz of Life" blog.

I have to say how lucky we are to have an economic system of free market capitalism in which Steve Jobs and others are enabled to work hard and are incentivized to hire talented people to produce the remarkable products that enrich our lives.  The workings of this system and the whole idea of economic freedom escapes the likes of Putin, the dictators and oligarchs of the world, and sadly even many in our society. They enjoy the wealth produced by the system but have no appreciation of it.

"Stay hungry, stay foolish."

Michael Lewis on Charlie Rose

If you are interested in understanding the European crisis, please spend 50 minutes and watch this interview of author Michael Lewis by Charlie Rose.  The interview starts with a discussion of Moneyball, Lewis's story of how the Oakland A's used statistics to build a team that accomplished something never before accomplished in professional baseball, despite having a lower payroll than other teams. Moneyball has recently been made into a movie starring Brad Pitt; and although it's a sports movie, it has embedded in it ideas about market efficiency, etc. that investment people appreciate.

The interview goes on to talk primarily about Lewis's new book, Boomerang, that explains the European crisis.  One important point I learned from the interview is how the whole mess is actually affected by culture.  Lewis covers it from the implosion of Iceland to the present.

Michael Lewis knows how to tell a story and bring complicated events to life by finding people who were intimately involved with events.  For example, The Big Short is a must-read if you want to understand the subprime crisis.  For those who might not know, Lewis is a former Salomon Brothers trader who gained notoriety writing about the trading room in Liar's Poker.

Charlie Rose, of course, is probably the finest interviewer of our time, and his interviews are worth watching just to appreciate his probing questions.  Many times he seemingly gets his subjects to think about their motivations, etc. for the first time.  You'll find his getting Lewis to talk about why the Greeks are angry at the Germans, despite the fact that they desperately need the Germans' help to get out of this mess, especially enlightening.

Disclosure:  Michael Lewis is one of my all time favorite writers.  Although I haven't read Boomerang, I anxiously go to the door when the UPS truck goes up the street.

Wall Street Protests

The problem with the protest on Wall Street is that, like similar episodes, many of the protesters tend to be clueless on what the protest is about.  Leaders of the protests tend to be closet Marxists (Susan Sarandon) who feel left out of an economic system that rewards merit or feel guilty because they have an economically valuable talent (Susan Sarandon) and who never understood why Marx was wrong.

Leaders of the protest seek others who desperately want  to be part of something - anything.  They seek those who have spent their life on the outside and who feel they have been wronged by the economic system.  Easy to find in an economy with persistent unemployment and underemployment.  The mob grows and they chant inane sayings about the economy and wealth - and the ever-present anarchists who thrive on shock value incite the mob.  Shock value and economic understanding don't go hand in hand. Mobs are more about wealth destruction than wealth creation.

Some are frustrated because they have gotten college degrees that they believed were the key to a high paying job and now are saddled with a large student loan and have no job or a low-paying job.  Others bought houses they couldn't afford and have slowly seen their dreams dissipate.  Many had jobs they thought would afford them a productive life that were swept away to other countries.  These are the discontented that the protests will gather up as it spreads.

To be sure, there are economic injustices and policies to protest. Money controls politics to too great an extent.  Our leaders have enacted harmful economic policies.  Economists have led us down the wrong road with the never-ending prescription extolling the virtues of free trade.  The tax system is out of whack.  Wars are fought for economic purposes and their real purpose is obfuscated.  There is plenty to protest.

Part of the problem - which the protestors will never get - is that the country has too many "safety nets."  It is to easy to get part of what is produced without contributing to the productive process.

There also is much to celebrate.  In our system, people are free to choose their own path.  You can pursue wealth - or not.  Your choice.  One thing is for sure.  As long as people can keep a goodly part of what they earn, the best and brightest among us (in the U.S. and around the planet) will work hard to try and figure out what we want.  They will think hard and work hard to produce the music, clothes, computers, and autos we want.  They will work hard to cure our diseases and seek innovative ways to educate us.  As I've said before on this blog, IMHO, we should feel like kings and embrace the opportunities afforded us.

The economy they protest creates the laptops and the cell phones and even the pizza they eat as they protest.  Something to think about as the protest spreads is whether shutting down bridges is the best way to go about getting desired changes.  That is, once the desired changes have been figured out.

2011 Year-to-Date Performance - BlackRock Standard Diversified Portfolio

One of the most useful research pieces available for DIY investors, I believe, is the "Asset Class Returns: A 20-Year Snapshot" table produced by BlackRock and discussed at Cedar Financial Advisors.  It shows annual asset class returns, color-coded, on a ranked basis so that investors can easily see the best-performing and worst-performing sectors for each year.

Similar so-called periodic tables of investment returns are produced by others, but  the BlackRock table is unique in its inclusion of a diversified portfolio.  The diversified portfolio is an excellent benchmark for many DIY investors.  It is comprised of low-cost, indexed exchange traded funds, as shown below. The 20-year annualized return of the portfolio was 8.89% for the 20-year period ended 12/31/2010.

The table shows how the return on the diversified portfolio has been much less volatile than individual sectors.  The table also shows the futility of predicting sector performance:  the best-performing sectors many times are the worst-performing sectors in ensuing years.  Overall,  the table is an excellent starting point for the all-important subject of risk management and asset allocation.

The updated performance of the components of the BlackRock Standard Diversified Portfolio over the first 9 months of calendar year 2011 is shown  in  the table:  CLICK TABLE TO ENLARGE 

Data Source: Morningstar

The overall portfolio has achieved a return of -5.14% over the first 9 months of 2011, at an expense of approximately 0.11%.




Disclosure:  The data shown here is for educational purposes only.  No recommendations are made.  Individual investors should do their own research and/or consult with a professional advisor.  Although data has been obtained from reliable sources, its accuracy cannot be guaranteed.  I am not affiliated with BlackRock or Morningstar.