Sometimes they (the media) get it and sometimes they don’t. This time the Wall Street Journal is getting it right. While the market reacted soundly to the better than expected GDP numbers last Thursday, jumping 200 points, the quality of the GDP numbers were questioned. Most of the jump in the economy was due to consumer spending, which is generally a positive thing. However, the gist was that the numbers reflected the two major stimulus packages put forth by congress and the administration. The 8k first time homebuyers tax credit and the cash for clunkers.

Without these two government interventions, the growth of our economy would have been much slower.

So what is the GDP anyway? It is devised with a relatively simple formula: Consumption (of the private sector, you and me) plus business investment plus government spending plus the difference between exports and imports. In other words, if exports grew by 15% and imports grew by 16%, the result would be a decline of 1% of the proportion that exports and imports make up the economy.

GDP = C + I + G + (E – I)

So the debate is on. Is this recovery different from previous post recession recoveries and is it one that could sustain itself if the government stopped providing all of this stimulus to us?

The answer from the majority of economists seems to fall into the “no” camp. Which is the economy would not be doing to well if it hadn’t been for governmental stimulus. The consumer just isn’t feeling all that confident right now and needs to have a strong financial incentive to make any big moves.

However there was some good news that should be emphasized from the GDP report. Reported, was a large increase in exports, brought about, in large part, by the lower dollar which makes the price of our goods to foreign customers very attractive. Cheaper prices to foreigners have boosted the revenues of companies like Caterpillar and Intel.

However, the 15% increase in exports was offset by a 16% increase in imports as Americans still continue to buy imported goods.

There is a certain feeling however, and this is the important trend developing that might be changing the course of this recovery. And this is the point I want to draw your attention to. The Asian Basin and other developing countries are performing much differently today than in the past and have kept growing at a strong pace. It is entirely possible that the long awaited export boom to developing countries might be the in the making, replacing the softness in consumer spending in the US.

One example is the recent activities of UPS (United Parcel Service). According to the WSJ, UPS has been investing heavily as it gears up for what it expects to be a trade-led recovery, even though third quarter profits fell 43% from a year earlier, It is in the midst of spending $1 billion to expand a sorting facility in Louisville, Ky., and is planning to open a new facility in Shenzen, China. UPS has stated that it very much believes that the recovery from this global recession is going to be led by global trade and the projects that have been sacrosanct…are the projects that support global trade and support export volume across the world.”

So don’t be too negative. Yes, the US economy will probably remain soft for a while, but the seeds of a new boom in manufacturing and technology business in the US may be germinating.

Remember that no one can see that far into the future. Remember that in 2001, when all tech companies and dot coms were collapsing and many experts were announcing the death of companies doing business on the internet, a small company came from out of nowhere and changed everything. Want to take a guess which company I am talking about?

Google, of course. So, stay positive on the future and invest accordingly.

“Uncertainty is the only certainty, and Learning to live with insecurity is the only security.”   

–John Allen Paulos

Date: 10/26/2009
Dow: 9,867

This current market situation as I see it:

It may be hard to believe, but the stock market has climbed 50% from it’s lows in March and is up 17% from January through September 30th. The question we are led to ask is whether this rally will continue or whether it will end. I think we can make the case that this spectacular rebound is similar to a tightly coiled spring being released after a full year of being pressed tighter and tighter. As soon as the economic stress started to normalize, the market sprung back sharply to a state of equilibrium. If this is the case, then we should expect a correction as the spring bounces back and forth finding a stabilized level. The reason is logical. Since when, does a market rise of such magnitude continue to climb without taking a without taking a breather? The answer….Never.

The real question today is whether the current decline signals a new downward path for the stock market or a simple and much needed correction. Only time will tell, but we do have a few clues we can use.

The Technical Point of View

I have been saying, based on technical research, that while we are now due for a correction, yet the intermediate term picture (3-9 months) continues to look good. Yes, we are seeing a few signs of weakening, but buying on dips is still a good idea.

For my day to day commentary on this, click the following link to join my Twitter Page.

The Fundamental Point of View

Looking at the economy and the world political situation, things seem pretty negative.  Tensions heating up over Iran and Afghanistan, the health bill in disarray and a surprisingly downbeat unemployment report have added to the worry among many things. Not all is bad, however. With low inflation and low interest rates, most economists are saying the GDP should grow 3-5% this quarter and 1-3% going forward. We also may be at the high point of unemployment which currently stands at 9.8%. Perhaps things will get better from here, not worse.

The Age-Old Dilemma

Investors are always faced with a quandary when forecasting the moves of the market in the short-term. You never know what will happen next so there is a bit of psychodrama that takes place with every market move. Since we are expecting a correction, allow me to illuminate the current dilemma

Situation:—Market moves down 5-10%:

The dilemmas:

1. You are afraid stocks will continue lower so you sell now only to find this was a temporary correction and you should have added to your investments.

OR

2. You have been waiting to buy-in because buying the dips has worked for the last 6 months, so you hold your nose and take the plunge and buy more, only to find this was the beginning of a next downward leg of the stock market.

There is no “best” answer to this problem. My strategy is to take an incremental approach to investing taking the emotion out of it as best you can. Thinking long- term, stocks are more likely to have a higher percentage return from these levels than they did at when the Dow was at 14,000.

But time is the key. The stock market is still the best mechanism for investing in the growing dynamism of capitalism worldwide. It is a MUST HAVE investment for your portfolio but like the mighty oak, it needs time to mature to its full potential.

Conscience Makes Cowards Of Us All—-And So Does Fear.

Date: 10/2/2009
Dow: 9462.46

The current market conundrum, as I see it:

The market has climbed 50% from it’s lows in March and is up 17% year to date through September 30th. It is obviously due for a correction and I wouldn’t be surprised if we were shaken out of our complacency to see a scary 10-20% decline. And why not?  Since when, can we expect a rally of such magnitude to continue without taking a breather? Think of the March to September rebound as a tightly coiled spring uncoiled after a full year of downward pressure.

Now that this spring has uncoiled we are back to a sort of normality. I hate to say “normality” because we all wonder what is “normal” these days. Bill Gross from PIMCO, calls this era, the “new normal” characterized by slow growth, the unwinding of leverage, low inflation and low interest rates—all of which he expects to continue for a while.

But I digress. The real question today is whether last week’s decline signaled a new downward path for the stock market or a simple and much needed correction. Only time will tell, but we do have a few clues we can use.

The Technical Point of View

I have been saying, based on technical research I use that, while we were due for a correction, the intermediate term picture continues to look good. This scenario has not yet changed as of this writing, but there is no question we are at a crossroads with regard to the near term direction of the market.

The bottom line is that upward market momentum, while still positive is weakening. We should have a better view this week and I will report this on my Twitter Page.

The Fundamental Point of View

Looking at the economy and the world political situation, things seem pretty negative.  Tensions heating up over Iran and Afghanistan, the health bill in disarray and a surprisingly downbeat unemployment report have added to the worry among many things. Not all is bad, however. With low inflation and low interest rates, (low mortgage rates if you can get one), most economists are saying the GDP should grow 3-5% this quarter and 1-3% going forward. We also may be at the trough of high unemployment which currently stands at 9.8%. Perhaps things will get better from here, not worse.

As usual, we never know what is going to happen next. If the market declines, we don’t know if it just is a correction or the beginning of a significant downward market move. The psychology goes as follows:

Market moves down 5-10%,

The psychological dilemmas:

1. You are afraid stocks will continue lower so you sell now only to find out you that this was a temporary correction and you should have added to your investments.

OR

2. You have been waiting to buy in because buying the dips has worked for the last 6 months, so you hold your nose and take the plunge and buy more, only to find this was the beginning of a nes downward leg of the stock market.

This is an age-old dilemma and there is no “best” answer.  My answer is to take an incremental approach to investing taking the emotion out of it as best you can. Thinking long- term, stocks are more likely to have a higher percentage return from these levels than they did at when the Dow was at 14,000.

But time is the key. The stock market is still the best mechanism for investing in the growing dynamism of capitalism worldwide. It is a MUST HAVE investment for your portfolio because, like the mighty oak, it needs time to mature to its full potential.

I appeared on CNBC this morning for a short segment about managing your 401ks.

Click on the following link to see the segment:

http://www.cnbc.com/id/15840232?video=1274849570&play=1

Click here to listen… 

A Brush With Bankruptcy

I want to tell you a tale. It’s a personal tale and one that should give pause to those considering bankruptcy due to current financial difficulties.
 
I started in the investment business in 1981. I was young and broke, like most young people and I managed to gain a position as a municipal bond salesman at a decent firm working for “peanuts” plus commissions. As time went by and I got a little smarter and better at my job, I managed to raise my status and join a major brokerage firm.
 
My compensation at the new firm was $500 per week for 6 months and pure commission thereafter. I had never earned the “whopping” sum of $500 per week so I was very excited. Right at that time however, we had just finished paying off my wife’s mustard yellow Plymouth Volare (boy did I hate that car!) and on the way to the Chrysler dealership to buy a new one, there happened to be a BMW dealership on the way. So I said to my wife: “Let’s just go in and see what they have”. Sure enough, three hours later, we walked out with a beautiful lapis-blue BMW 526.
 
Little did I realize that after the new car smell wore off, the cost of the monthly payment would just be the beginning of my struggle to afford this car. Standard maintenance was $500 a shot and unfortunately the air conditioner kept leaking pushing me into poverty at every turn. I had no business buying a BMW earning $500/ week, but the salesman was good at his job and he figured out a way to get me into this car. I was like the sub-prime borrower buying a $500,000 house; I was buying well above my means. Maybe it was the salesman’s fault after all! 
 
Luckily, I started doing a little better financially so I was able to keep up with all of this, but my life style started increasing as fast as my paychecks.
 
This went on until October 1, 1987. It was on that date that my wife and I decided to step up to a bigger house and mortgage. After all, my income had been getting larger along with the size of our family so it seemed like a good idea at the time. Unfortunately time was not on my side because exactly 17 days later, the stock market crashed, posting its largest decline since the depression– 22% or 500 points in one day!
 
This is when things started to get tough. It was my first experience with a bear market and investors were frozen with fear. My earnings slowed down considerably and the only way to keep up with my mounting obligations was to use whatever credit was available. So out came the credit cards and home loans. This went on for a few years and was not a pretty sight. Some of my colleagues were in the same boat, and a few of them decided to declare bankruptcy as a way of emerging from their problems. I considered it but was very hesitant. I didn’t know what the future ramifications would be, and I felt it was wrong to do it if I could find the wherewithal to pay my bills with the hope of a return to higher earnings as the situation improved. I believed in paying back what I owed.
 
The market, economy and my earnings eventually improved but it took a very long time to dig out of the hole I had dug for myself. To give you a small idea of how bad things got, I remember needing a new refrigerator but not having a spare dime. We went to Sears, filled out a credit application and sweated out the wait for approval. I didn’t know what I was going to do if I was declined. How would I live without a refrigerator? What had I gotten myself into? Thankfully, I wasn’t declined so the refrigerator was delivered the next day. What’s important about this experience, besides from the feeling of panic, was the fact that a year later, we sold our house and left the refrigerator to the new buyer. Incredibly, I hadn’t finished paying the refrigerator off, so I continued paying the bill for years, even though I was no longer using it.
 
Finally it dawned on me; (by that time I had studied and received my Certified Financial Planner designation) that the lesson to be learned from my trials was to understand the financial cycles that affected my life. I vowed that with the next economic upturn, I would not spend all of my money; I would start saving it for the next down cycle I knew would always come.
 
Finally with my bills paid off and extra money coming in the door, I built considerable cash and investment pile. I can only try to describe the profound impact that being ahead financially had on my life. My sense of security increased as well as my confidence and competence as a Financial Advisor. This was many, many years ago, but it was an important and hard won lesson which I carry over to this day-and it was a lesson which improved my life many times over.
 
So here’s an idea to help you learn the lesson which took me years to understand.
 
Divide your thinking into two ideas.
 
First, think about your personal financial cycle. Are things going well financially? Job secure? Money in the bank? Take a piece of paper and write the letter P for personal and an up-arrow next to it. 
 
Next, think about the economy in general. Is it bad or good? If it’s good, across from the P -up arrow- on the same line or in a little box write, E -up arrow. E for economy. There are four possible combinations: 

Personal:——————————— UP               Economy:——————————— UP
Personal:——————————— UP               Economy:——————————— DOWN
Personal:——————————— DOWN          Economy:——————————— UP
Personal:——————————— DOWN          Economy:——————————— DOWN

When your personal “P” is up, and the economy is up, save money for the inevitable down cycle.
 
When your personal “P” is up, and the economy is down, invest for the future
 
The worst case is Personal down and Economy down, because the two are inexorably tied together; i.e. out of a job (Personal) with jobs hard to find (Economy).
 
Remember the life of the farmer who is certain, as dark follows light, that winter will follow summer. He knows to save his extra harvest by canning or bottling it for the upcoming winter. This is the food which will enable him and his family to survive.
 
It is no different for us, just a little harder to see. Use my idea to simply chart the summer, spring, fall and winter of your personal financial life. Compare it to the economy as a whole and follow my aforementioned advice.
 
Oh and by the way, I decided to start my own business in 1996 to break away from the Brokerage business. When I applied to become a principal of my firm, a question on the form stood out like a sore thumb. “Have I ever declared bankruptcy”? Thank heaven my answer was no because the law does not allow one who has declared bankruptcy to operate a registered investment advisory company. My future would have been inexorably changed for the worse. This was one of the unexpected consequences that was not immediately apparent during those troubled times.
 
The lesson is clear. Be very careful, with big life decisions like declaring bankruptcy. While the reasons on the surface may sound valid and the path easy, you never really know the full ramifications of this type of action.
 
~Steve

All investors are compelled to guess the future direction of the economy and the stock market. Whether by gut feeling or the use of sophisticated mathematical algorithms, the future is not predictable and any attempt to forecast it is a futile enterprise. Past performance will give us no more insight into the future than crystal balls or astrology. Warren Buffett quips that if past performance were all that was required to be successful, all of the rich people would be librarians.  Furthermore, Wall Street types who forecast the market really have no more clue than you or me; however they compound their problem by giving pin-pointed forecasts which are wrong most of the time.

It is far better to approach this question by coming up with a list of reasonably valid scenarios that include the full range of economic outcomes and then try to attribute a rate of return for the market over the next 5 years. While not perfect, this can be done with some accuracy, due to the fact that we are forecasting a range of returns over a longer time horizon (5 years).

Scenario 1: “Muddle Through”

This suggests an economic recovery in late 2009 or early 2010 continuing with a less than normal recovery for several years. Also Inflation gradually rises.

 
Scenario 2: “Stagflation”

This also suggests an economic recovery in late 2009 or early 2010 and a less that normal recovery for several years. However it is followed by STRONG INFLATION in the 5-8% range near the end of the five year period.

Scenario 3: “Severe Recession Accompanied by Deflation”

This is a bitter scenario because it forecasts an extended and deep recession causing prices to spiral downward through 2010. The recession does end but the following economic growth is very anemic.

Scenario 4: “Goldilocks”

Everything is just right because the Government’s “kick-start” gets the economy growing in late 2009, followed by average growth with moderate inflation.

Since these are the four scenarios most likely to occur, the next question we need to ask is: What are the possible returns of the stock market under each scenario?

Before examining the chart, let’s get a little knowledge about a few of the numbers that appear in the first two rows.

First we want to add up all of the companies’ earnings that make up the S&P 500 and compare them to the price of the S&P. In 2008 the S&P’s earnings added up to about $501.  As of this writing the index of the S&P stands at just under 900, therefore a simple math calculation puts the price as a multiple of earnings to (PE) around 17. Just to reiterate, this means the average company in the S&P 500 sells at 17 times its earnings.

Now this PE multiple thing is not a static number. A lot of things like interest rates and inflation among other things can affect it, but our research forecasts the following earnings and PE ratios under each of the four scenarios. The chart below organizes all of this and forecasts possible returns based on a given price level of the S&P 500.

  

 

 

Look at the left hand column under “Starting S&P 500″. Go down to the number of 900 which is where the S&P 500 is at the current time. Following across, one can see the possible returns under each scenario. Under the Muddle Through scenario, the possible future annual return of the S&P 500 over the next five years is 5.2%. Under the Stagflation scenario it’s 2.7% For Deflation it is between -3.5% and .5% and under Goldilocks; 13.9%. (Hurray for Goldilocks).

 
Realistically, we don’t know which scenario is going to work out so to be extra careful, we would want to buy the S&P 500 at a lower price just to build in a margin of safety.

 
Move up to 800 on the left hand column and the numbers start to look better, but not ideal.

During the latest  sell-off which occurred in March of ‘09, the S&P 500 dipped to 680. I don’t think we will see the 680 lows again but I do think 750 is a good possibility, so let’s look at that.

The possible future returns at 750 range from .05 to 18.5%. If we eliminate the extremes of deep painful recession and a goldilocks economy, we are left with returns in the 7% to 12% area. This is a decent return and one that will create real wealth for those with the patience and fortitude to stay invested. This return won’t come easy, however. Remember I’m forecasting an average annual return. The word average sounds safe, but it is one of the most dangerous words in the investment vocabulary.

 

“You know it don’t come easy…”  

– George Harrison

 

For example, it can be said that if you have your head in the oven and your feet in the icebox, your average temperature could be 98.6o, but of course you will probably not be around to measure it.

The same is true for investing. To get an average rate of return of 10% you will probably have to experience annual volatility of 20% and maybe more. That means that the range of returns in any one year could swing by 40%. This is not for the faint of heart and as we saw last year, many were not able to stomach it and keep their faith about the future.

There we have it; an idea of possible future returns under four economic scenario at numerous price levels of the S&P 500. This is not crystal balling, nor is it wild guessing. In my opinion, since one of these four events will actually occur, we can choose our entry back into the market accordingly. We can control our investing destiny rather than having the market or our emotions control us.

This is the essence of successful investing and the essence of wealth creation.

Steve…

Click here to listen…

 The 7 Habits of Highly Defective Investors 

1. They don’t have an asset allocation plan

We’re all familiar with the common wisdom that says that 90% of a portfolio’s performance is determined by the portfolio’s allocation. I don’t know if that is true or not, but the fact remains that having an asset allocation plan and sticking with it through rebalancing, makes a lot of sense. Why, because it brings discipline to the investing process. When a portfolio has an asset class that performs extremely well compared to the other asset classes in the portfolio, human nature tells us to the sell the poorer-performing asset classes and buy MORE of the asset class that just performed well. In reality, we probably should do the opposite and sell some of the appreciated asset class and buy more of the underperforming asset classes.

2. They invest for the short term, using long-term investments

This ties in with the last point. Listening to a person brag about their 60% return can make anyone envious. However, keep in mind that they probably are leaving out some important details such as the fact that all their other stocks are in the toilet. In other words, congratulate them and change the subject.

6. They watch too much CNBC

I’m not saying CNBC is a bad thing. However, I am saying that too much CNBC can turn a long-term investor into a short-term trader. Consider changing the channel or cutting back on the business news.

7. They pay TOO MUCH in fees

I cannot stress enough the importance of keeping costs down when investing. For the most part, the more an investor spends in fees, the less they will have at retirement.

Click here to listen…

Been Down so Long it Looks Like Up to Me
                                           –Richard Farina

The Current Dilemma.
 
Now that the stock market has rallied, investors are in a quandary. Should they continue to hold stocks and hope to recoup more of their money back, or should they sell into the rally in the hope of avoiding more carnage if the market falls once again? They ask themselves: “What if this is just a rally in a continued bear market? They would be right to think so, just look at the chart below.

Chart 1

 
 
Every single market rally was followed by a decline, some benign and some quite vicious (August 2008 -December 2008). The same thing happened between 2000 and 2003.

Chart 2

 However, instead of continuing its downward slide like most experts forecasted, the market entered a new bull phase lasting until November 2007. Chart 3 shows the rise starting in 2003.

Chart 3

 
Putting It Into Real Dollars

If the value of your 401k or IRA stood at $500,000 on October, 2007, it would have declined to $225,000 by February 2009. One month later, the value of your investments would have been grown back to $275,000 (Using the S&P 500 as our proxy).

Therefore any rally as represented in Chart 1, would have represented a selling opportunity. For example, by March 10th 2008 your $500,000 would have declined to $415,000. By November 17th, it was valued at $254,000.
Just like the 2003 period, we never know if the previous bottom is the final bottom. Unfortunately, looking at the past does not give us enough information to predict the future. Like driving, looking only in your rear view mirror, the past may give clues, but its ability to forecast is limited.

Is There Any Way To Cope With This Uncertainty?

Yes, but the first thing to do is take a fresh look at today’s environment. Put the past behind you and look forward. Ask yourself if the economic landscape has changed since those dark days of 2008?

I would have to say that compared to the terrible events in October and November 2008, we have seen positive changes in financial markets. It is just a flicker of change, but change nevertheless.  I know, a flicker is not a flame and a few drops of water do not make your glass half full, but notable changes are taking place. Here is a short list:

1) The Government has stepped in and backed nearly everything.
2) Banks now have new rules regarding the pricing of their bad assets.
3) Banks are starting to lend again. As a matter of fact, Bank America just announced they are re-entering the jumbo mortgage market.
4) GMAC, the financing arm of General Motors, also said Wednesday that it would resume making loans to subprime borrowers in order to spur sales.
5) The decline in orders for a number of companies is beginning to flatten out; suggesting the rate of decline is slowing in many cases.
6) Production in increasing in China.
7) The stimulus has not even started yet.
8) Interest rates are at historic lows.
9) The price of oil is showing signs of life.

The jury is still out and many economic challenges remain and many smart people continue to predict the economy will get worse before it gets better.  However, there is a sense on my part, of an end to the free-falling economy and stock market.

How Does One Make A Decision Under These Stressful Conditions?

One way is to try and determine if the stock market is “under-valued”, “over-valued” or “fairly-valued”. A person I respect, who has studied valuation successfully for many years is Jeremy Grantham, head of GMO. (Click on the link to find out more about him). Grantham uses a simple investment idea in a sophisticated way to determine “fair-value”. He also understands there will be times when the markets will go too high and too low relative to “fair-value” and he knows that what goes up will eventually come down and vice versa. He calls it “regression to the mean”.

The chart below shows the performance of the “DOW” from 1965 to 2007. The straight line going up the middle is the trendline or average. The tech bubble is the area above the trendline between 1998-2001. Interestingly, after the big decline in 2002, markets did not go below the trend line, indicating a move back to fair-value. The market rose again until 2007, declining dramatically bringing the market to what  appears to be a significantly “under-valued”. This is a simplistic picture and not meant to directly reflect Grantham’s calculations, but it does illustrate the point.

 
 
Grantham thinks fair-value is currently around 900 on the S&P 500 (The DOW is not a very good measure of the market anymore). Today the S&P 500 stands in the lower 800’s, having sunk to a low of 675 on March 9th, 2009.

This is information we can use. We can be more assured of success buying below the trendline than either at it or above it. The only problem, as Grantham has experienced on more than one occasion, is the curse of being TOO early. These trends of over and under valuation do not change overnight. Sometimes they can last for years and be quite frustrating.  If the market is over-valued and you sell, it can continue higher and make you feel you are losing opportunity. If the market is under-valued and you buy, it can become even more under-valued making you feel you have made a big mistake. During the period between 1995-2000, Grantham shouted loudly that the market was severely over-valued and was deemed dead wrong for 3 years. He stuck to his guns however, and even in the face of losing many accounts, he was eventually validated. (Warren Buffett often suffers the same fate).

Today, while everyone is screaming the “sky is falling”, Grantham is buying stocks during the deepest of the market declines. He can do this because he is willing to be wrong for periods of time thinking he will eventually be proven right.
My job is a bit different. I must take a more exacting course because my first concern is to preserve capital.  Instead of grabbing the extreme bottom or top of the market, my philosophy is to grab the middle two-thirds thinking that it should be enough to create wealth over the long term.

To this effect I remain cautious but poised at the trigger to enter at the “right” time.

Click here to listen…

The Doom and Gloom of it all…

Many investors are now asking when their stocks will get back to even.  My response is always; “What do you mean by even? Is it the amount of money you initially invested, or is it the amount that your investments were worth on the day the Dow hit its high on October of 2007?” Human nature, being what it is, the answer is usually the latter: the value at its high. We all tend to anchor on the highest number we can remember.

Think of your house, for example. You probably remember the price your neighbor’s house was sold for during the very good times. I know I do. My house was originally purchased for $215,000 in 1996, and I remember seeing it worth over $500k as other homes sold in my neighborhood at that price. (Of course, they didn’t have the extra features my home had). When I looked up the value of my home on Zillow.com the $500,000 value was further reinforced.

I understand my home is now worth somewhere in the neighborhood of $300-$350,000 which is a decline of 30-40%. Yet, from my initial purchase, my home is still higher in value by 40-60%. If  I’m not selling, how important are these numbers to me?  Important in mainly one respect. What we all want financially from owning our own home is for the value of the home to keep pace with the cost of housing in general. In other words, in order for me to have enough flexibility to move to another home, I would need the capital from my first home to be close to the capital needed for my new home. If prices are rising, I will have more money to pay for a new house whose price has also risen. If I was renting, I would not have the money to pay for the higher cost of a new house. Fundamentally, home ownership enables us to keep pace with the rising (over time) cost of housing in the United States.

You might say: “Fine Steve, but that’s your house, what does this have to do with my investments?” I suggest it’s very much the same thing.

Think of your 401k or IRA for example. Values were much higher 16 months ago (I’m sure you remember THAT number) and yes, today’s value is lower, but are you spending any or all of that money right now?  If you’re not using all the money today, it’s like staying in your home. It doesn’t really matter what its worth this day or this year. It will only matter when you are ready to spend it all.

You may reply: “But, I came into the market late and the current value of my 401k is LOWER than all of my monthly contributions combined! I don’t have the satisfaction of seeing the value of my 401k worth more like you do with your house.”

True, but what is the real effect on you? In hindsight we know now that the values 16 months ago were high and perhaps the future rate of return from those high numbers will not increase much for the next 5 years or so, but the future rate of return from today’s prices, should be MUCH higher.

Let’s look at the stock market. The Dow reached approximately 14,000 in November, 2007 and let’s say from that point, stock prices rise at a rate of only 3% per annum on average. (Not a very good return from the 14,000 level.) If this is true, the level of the Dow will be 17,734 in 10 years. With the Dow now around 7,000, the annual rate of return from 7,000 is 9.75%. This is far better than 3% you would earn if you did nothing, so you can see the benefit of continuing to invest when prices are low.

Of course nothing is ever this simple and there certainly are unknowns. Maybe the market won’t appreciate 3% over the next 10 years from the 14,000 level (even though history suggests a high probability that it will earn more.)  Nevertheless, right now you only have to beat the 2.5% return you earn on your risk free investments like CD’s or Treasuries to be successful. That, I think should be relatively easy to accomplish.

How then, do you weather this awful downturn? 1) Turn off financial TV. (…except when I’m on, of course.) 2) Suck in your belt and get your emotions under control. Think past this recessionary cycle. Investigate the downturns of 1973-75, 1980-82, 1990-91, and 2000-2002. You’ll discover each one of those periods felt scary and different from the previous recessionary period. Experts lectured about the end of capitalism or the irreparable damage to America’s position in the world. These lectures and conjectures continue today.

Remember though, if you didn’t buy into their negativity back then, you likely would have profited very well, and chances are, doing the same in these days of uncertainty will profit you very well indeed.

Click here to listen…

The Cycle of Market Emotions

There is a psychological “sea-change” taking place before my eyes and I am beginning to recognize a sense of fear I haven’t seen so far in this cycle. Many I talk with, think the stock market is headed for a huge fall and absolutely want no part of it. I can understand their fear, but this is starting to feel like the beginning of one of the big mistakes people make when the news is at its dreariest. Allow me to explain.

There is a natural cycle to any “risk” type of investment. Whether we are talking about Gold, Real Estate, Foreign Securities, -even the bond market. As markets rise, people become hopeful and encouraged. They may start to buy-in as they notice the economy and the stock markets improving. This is natural and healthy. As the markets continue to rise, hope turns into optimism and excitement as their earlier decision is reinforced by the rising market. Every new investment is rewarded with a higher value a few weeks or months later. Investors are feeling very smart while being constantly reinforced by the news of improving fundamentals. Companies are hiring and expanding and profits are rising. They are also growing domestically and internationally and Countries, which historically have had impoverished financial systems, start improving bringing wealth to many of their people who once had little hope of a decent material life. All is good. So good, in fact, that now new people are entering the market trying to get in on the action.

Let’s examine Real Estate as a recent example. As interest rates declined and home prices rose, more and more buyers entered the market with sound fundamental reasons behind their purchases. Homes were affordable and rising prices reinforced their decision that the home purchase was a good idea. This continued for many years reaching a point where prices rose well past reasonable fundamental value.  By the time speculators entered the market, people were predicting ever higher prices, due a rising economy as far as the eye can see. This had real estate investors stirred up to the point of euphoria and hysteria.

It continued for a relatively long time, well past the point of rationality and reason. Investors just continued to focus on rosy news reports and rising prices until just when everyone involved reached the maximum point of euphoria, the music stopped. This point of maximum euphoria is the point of maximum financial risk. In other words, when you are feeling that investing is easy and low risk, and you are feeling most secure and assured, investing is at its riskiest point and the probability of high future returns are low.

What has this got to do with today’s investing environment? You might be wondering why I’m talking about rising markets when we are in a completely different part of the economic cycle. Prices are low and seemingly continuing lower. Nothing good is being reported by the media and now, even the White House is forecasting doom unless they get their money. In addition, I am starting to get panicked calls from clients and others who think they should be out of the market at any cost.

This is the cycle I just described turned on its head. Let’s see how we got here.

In early 2008, prices began to weaken and the market became more volatile. Investors felt a little anxious, especially as volatility picked up, but the experience of the last few years had demonstrated to them that holding on would be the best thing. This was not unreasonable. Stock prices were nowhere near their highs, relative to earnings, as observed before the dot com crash of 2000. The economic news was still pretty good and while there were some difficulties in the mortgage sector, the FDIC, the Federal Reserve and the Treasury Department seemed to handling things in an orderly manner.

But the news began to get worse and fear rose amongst investors when in October and November Wall Street began to unravel. Banks were in need of huge infusions of cash, brokerage firms were crumbling under the weight of bad investments and too much leverage and access to credit became so restricted that borrowing virtually ceased. The Stock Market had a heart attack.

Fear rose to desperation and panic as the news started to get pretty bad regarding the economy and everyone finally opened their statements and gasped. So now investors’ fear factor started rising but no one really wanted to sell into that great decline. Now, a few months later, clients tell me about so-called sophisticated investors who are saying they are pulling out of the market. I am hearing from liberal radio that the Bush administration didn’t tell Obama how bad it really was and conditions are much worse than they appear. CNBC is full of experts making prognostications about the rest of the year and, day after day, the front page news tells the facts about a deteriorating economy. This feels bad and people are discovering that successful investing is hard to do and can be high risk.

I am suggesting that while this condition can go on for a while, we might be near the flip side of the cycle I described earlier-the opposite of euphoria. Remember I just said the following: “When you are feeling that investing is easy and low risk, and you are feeling most assured, this is the time when investing is at its most risky!

Now I am saying that in these times when investing is hard and seems very risky and you are most fearful about your money, it is the time when investing is actually safer and more rewarding in the future.

That is why Buffett and others are buying today.

Click here to listen…

Introducing Your New Partner, Mr. Market

Let me tell you a story about two partners that went to work together every single day. The first partner, you could say, was the operating partner; let’s call him “Mr. Operator”. He toiled a full day, growing and managing his business in a very diligent manner. The second partner did not operate the company, but he was the guy with the money. He was the investor; let’s call him “Mr. Market”. Mr. Market would talk to his partner, Mr Operator, every day without fail, since the very first day of the business. Each day Mr. Market would offer to buy the business at a price he thought represented the future value of the company.

However, there was one caveat. Mr. Market suffered from manic depression, and like most manic depressives, he was elated for periods of time and hugely depressed for others. On the days he was feeling most positive and optimistic, he would offer a sky high price assuming the future prospects were unlimited. On the days he was depressed, he would offer a very low price, afraid that Mr. Operator would unload the company at too high a price.

This went on day after day after day. Even though Mr. Market was the money guy, Mr. Operator was a smart guy too. He really understood his business and had a good idea of what is was really worth. He never took Mr. Market’s offer price as an indication of the value of the company. He knew that one day he would sell to Mr. Market, but it would only be at a time when Mr. Market was in his overly optimistic, manic phase. You see, he knew what the business was worth, so he could choose the price at which to sell. He knew that Mr. Market’s price was based more on emotional factors than on facts.

All investors who buy and sell securities in the stock and bonds markets have Mr. Market as a partner too. As the operator of your investments, you may choose to buy-from or sell-to him at his stated price, always aware that the choice is yours. You see, it’s up to you to know the value of your business, never confusing the price that is offered with the real value of your investment. It may or may not be the true value, but it is up to you to know.

Since the beginning of 2009, Mr. Market has been quite manic. As expected, Mr. Market was feeling pretty good. A new President, a new congress, the promise of change lifted his spirits and his view of the future. This is a common occurrence at the beginning of most new years, and in true form he offered higher and higher prices for a few weeks—just a few weeks, because soon his mood began to darken once again. He started concentrating on the negative. Yes the economy was bad, and the media was sighting statistics that described it in detail, but Mr. Market acted confused, and couldn’t make up his mind from day to day. One day, he would push up the price for companies and the next day he would push them back down like a see-saw. Day in and day out he has been acting this way for the entire month. If news hits the screen about the fall of “New Housing Starts”, prices go way down. If another report surfaces about a rise in the number of houses sold, the market zooms higher.

If you are an active trader, you have to decide whether you are willing to trade with this manic depressive, not knowing what mood he will be in- on any given day. Or you can sit on the sidelines and wait for him to present an offer to you to buy something at a low, low price. If you do decide to buy from him at a low price, you can now wait for the return of Mr. Market’s overly optimistic periods. You have to know what your business is really worth and you can choose to sell to him on your own terms.

Right now, I choose to wait on the sidelines until Mr. Market gives me an offer I can’t refuse.

Looking at January

Concerning January’s performance, I will share with you some thoughts and insights from Sam Stovall, Chief Investment Strategist, Standard & Poor’s Equity Research:

The S&P 500 fell 6.4% month to date through January 29. This would be the second consecutive year in which the S&P 500 declined during the opening month of the year. Since 1929, there have been five other times that the “500” tripped up in two successive Januarys (1956-57, 1973-74, 1977-18, 1981-82 and 2002-03). In the remaining 11 months of the second year of these “double-dips,” the S&P 500 gained an average 3.0% and rose three of five times. But don’t get your hopes up too quickly. Twice the market fell in January three years in a row (1939-41 and 1968-70).

Why should we care if the S&P 500 rises or falls in January? Because of an old Wall Street adage, first observed by The Stock Trader’s Almanac that states: “As goes January, so goes the year.” A positive performance by the equity markets in January has typically led to a gain for the full year, while a negative performance in the first month usually signaled a decline for the entire year. Of course, past performance is no guarantee of future results.–Sam Stovall, Global Equity Strategy, January 29, 2009

What to do now.

What am I doing? I’m culling the herd, so to speak, getting rid of the weakest investments. I am buying bonds at 6+% and dabbling in the preferred stock and junk bond arena, getting yields of 11 and 15%. These investments are riskier, so consult your advisor before doing this on your own.

Stock wise, I’m still on the sidelines having ended my “phasing in’ strategy earlier in the month due to negative technical readings.

At this moment, there are no signs pointing to a rising stock market, which leads me to the conclusion that the next few quarters might be rough.  However, many stocks remain at historic lows and any sign of a bottoming out of the economy will, in my opinion, send these stocks soaring once more.  Patience will be needed and patience will be rewarded.  In the words of a better philosopher: “Patience is bitter, but its fruit is sweet.”–Rousseau.

Three Important Questions

• What to do now in 2009
• How to get a decent return without so much risk!
• What to hold and what to sell

Before answering these three questions please allow me to recount how we got to this point in the first place.

2008 began like any normal year. The economic outlook was good as was the health of the stock and bond markets. I felt there would be some economic slowing throughout the year and bumpier ride in the stock market so I raised cash in advance. It was like the mood you’re in on a beautiful day 20 minutes before your house disappears in a Tornado.

The tornado that comes out of the blue then bam! all hell breaks loose.

First, oil rises to $148 per barrel, and everyone’s paying 4 bucks and over for a gallon of gas. Experts start predicting a rise to $200 per barrel and most other commodity prices start going up dramatically causing inflation to rise with no end in sight. (We start seeing videos of masses of people from China and India switching from bikes to cars). Then, as fast as oil prices rise, the price drops to $40 and gas at the pump is $1.80 again.

Now we hear that housing prices are declining faster than expected and many homeowners are unable to make their payments and foreclosing, so the banks start losing billions and the economy experiences a credit panic not seen in 75 years. This scares the heck out of everyone causing the stock market to unravel which is followed by a huge government bailout as banks continue to weaken. Then, established investment companies start merging or going out of business and interest rates rise dramatically on everything but Treasury obligations. The final icing on the cake for 2008 is the uncovering of the most diabolical Ponzi scheme in history. What a mess.

But just as seems it could get no worse, the panic subsides, and credit markets start to improve. (See my commentary: The Great Thaw, week of January 12, 2009)

Here we are today, bewitched and bewildered, sitting on a pile of uncertainty wondering if the storm has passed, wondering if this hellish ride is over. Hoping it is safe to come out of the bunker to assess the damage.

In order to know if it is safe, let’s look at the current state of affairs and the important numbers to ponder:

Interest Rates:

• Rates are falling. Mortgage rates are 5+% but they want to go even lower.
• T-bills are at .2% and you would only get 3% if you loaned the Government money for 30 years!
• Prime is at 3.25% so if you have a home equity line of credit you are only paying a pittance.
• CDs are at 2-3%
• Many stocks are paying higher dividends than Treasury bonds which we haven’t seen since the 50’s.

This is good news.

Inflation:

Declining, and expected to stay low for a while.

Good news.

Unemployment:

Rising and rising fast. The economy basically shut down in November and December and companies are adjusting to the situation.

A strong negative, especially since consumer spending makes up 70% of our GDP.

Real Estate:

Still declining but at a slower rate. Housing is affordable once again and low interest rates will help too. Homebuilder stocks are up 40% in the last 2 months. Maybe the market sees something new brewing

Look for some positives later this year.

Oil:

Low and likely to stay low as the economy remains weak. A lot of the banks and hedge funds are no longer driving prices wildly up and down. Typical supply and demand dynamics have returned putting some sanity back into pricing.

This is good.

Banks:

Still reeling and not ready to come out of the woods for a while.

A big negative.

Corporate Earnings:

Corporate earnings are soft and won’t move until credit becomes available once again to the consumer. We need the banks to improve dramatically before that happens.

Not good.

Government Spending:

A trillion is the new billion. A lot of stimulus and economic support is coming our way and our new president is committed to getting the economy back on track by investing in infrastructure and public works programs. It will be interesting to see how well this works, but the old saying: “don’t fight the fed” means you don’t want to bet against this huge amount of stimulus.

For the economy this is good right now. For the future????

Stock Prices:

Stocks are valued as a function of future earnings and current interest rates. Low rates make stocks more valuable. So this is a positive. Future earnings are also important. With rates this low and earnings expected to grow, on average, 6-8% per year, stocks are currently a good investment and will probably yield double digit returns in the next 10 years.

Prices are attractive

Bonds:

• Investment Quality Bonds yield over 6%
• Preferred Stocks yield over10%
• Low quality (junk) bonds are yielding 15-20%. This is a risky category but you are, in my opinion, getting paid to take the risk.

Bonds are very attractive.

Three Important Questions Answered

• What to do now in 2009

Keep a decent amount of cash in your accounts but don’t sell out of your stocks entirely. Get rid of the weakest companies and replace them with high quality companies. Look for so-called “fat-pitches”. These are the pitches you get in a game of softball that you just know you can hit out of the park. Wait patiently to buy any stock and then “swing” when ready. That is what we’re doing.

• How to get a decent return without so much risk!

Bonds are a very good way to do this. Picking individual corporate bonds is getting trickier, so for the time being buying mutual funds or index funds is a better way to go. Let the manager decide on which bonds to buy.

• What to hold and what to sell.

Today, picking the right individual stocks is more risky than ever so I would invest in either larger index funds that invest in the S&P 500, RUSSELL 2000, overseas markets and the like. This will help you get broad access to the market without the risk associated with owning just a few stocks. When this market turns, these funds will do very well.

Add some gold to the mix and some funds which can hedge against market downturns.

Summary:

All in all, I’m not entirely negative right now. The news will continue to be mixed with a negative slant, and it may get scary once again, but stock prices are reflecting most of what is already known. If there are any positive surprises, the market may rise strongly, if the surprises are worse than expected, be ready for more turmoil. Hopefully you have planned for this and you will survive to fight another day.

Finally, regarding very short-term market conditions:

We did get a cautious buy signal about four weeks ago and started to invest some sideline cash on a stepped-in basis adding 20% at a time. That signal has failed to follow through so I am currently in a holding pattern waiting to see what we will do next. I will keep you informed.

Click here to listen…

The Great Thaw

We are now going through a period which I am calling the Great Thaw and in order to have a great thaw you need a very deep freeze, and boy did we ever get one in 2008. It was the greatest economic freeze we have seen in a long time.  It occurred in October and November and created a panic so furious that practically every investment around the world fell sharply in value. In those few short months, the world financial system nearly came to a crashing halt mostly caused by a deep freeze in the credit markets. 

Like a river which flows when temperatures are moderate, but stops flowing as temperatures decline, the flow of money can also stop circulating under extreme conditions.  These conditions occur because banks lose confidence in the value of their own investments. In a tizzy about the loss of their own capital, banks become less confident about lending to other enterprises as well.  You see, if banks aren’t sure they will get their own money back from the loans they provide, they will stop lending money to others.  When banks can’t trust their best clients to pay them back, lending stops; hence, the deep freeze.  One way to tell the extent of the freeze is to follow the rate of interest banks charge on loans.  If money is tight, interest rates will rise, and rise they did in 2008. Commercial paper rates reached 7% (which means that no money was really available) and LIBOR, the rate banks charge each other, rose to such extreme heights that capital became literally unavailable to companies in need. Once money no longer flows, the financial system can seize up and bad things will happen.  I don’t want to think what this may have meant for the rest of us.
 
To the rescue came the Federal Reserve and the Treasury. They rushed to get billions of dollars released to the banks in an effort to shore up their capital, and prevent the economy from grinding to a halt.  The government tried a number of different strategies, some of which did not work or worked too slowly.  The strategies’ degree of failure or success, as measured by the reaction of interest rates and the stock market, proved discouraging. As a result, the Federal Reserve decided to insure everything the banks owned and every investment the banks had made, without discrimination.  The scope of this governmental intervention surpassed anything seen before.
 
The Federal Reserve even reached out to private companies who asked for help. These companies have been in the news all through this crisis; AIG, General Motors, GMAC, Fannie Mae and so many others.  The government allowed investment companies like Goldman Sachs to become bank holding companies affording them the same privileges and protections as Citicorp, BankAmerica and Wells Fargo.  From my perspective, having been in the business for so long, conditions must have been very, very bad for a top-notch firm like Goldman Sachs to give away their Golden Goose in order to survive.  Companies like Goldman Sachs hearken back to the industrial age and have always been fiercely independent risk takers.  These are the companies that have survived trying times before and earned fortunes for their partners and shareholders.  Watching these companies turn into banks, boring and highly regulated, is an astonishing event to experienced investors. I wrote during that time that I had seen “the mountains move”, and as I continue to view the investment landscape from my office every day, I still see those tectonic shifts taking place right in front of me.  However——-I have some good news.
 
The Panic of 2008 is over.
 
Companies are starting to enter the market again and issue bonds to raise capital.  Important interest rate levels have returned to normal and investors are starting to come out from their hiding places and invest once again. This is the beginning of the Great Thaw (at least in the bond market). This thaw will trickle down to the rest of the economy in due time. Like a person who has experienced any serious trauma, it will take some time for the economy to shake off the shock. As interest rates come down for mortgages, and housing becomes much more affordable, buyers will return and the housing market will improve once again. The cycle will swing up as it always does. This is just one example of the benefits from the Great Thaw and I look forward to many others as the years’ progress.
 
Therefore, I am optimistic about the next few years and I am inclined to begin adding to riskier investments as I see these benefits of the Great Thaw.  Am I saying the economy is getter better right now? No, I am not.  Am I saying the bear market in stocks is over?  No, because it’s probably not.  Right now I am only saying one thing; the deep credit freeze is over and the Spring Thaw is upon us.
 
I look forward to a glorious summer.

Fratricide?  Patricide? Genocide?

Investicide

Somewhere among the moneyed elite, you may have heard the following conversations:

“I hear you want to invest in the fund, so tell me about yourself (Let me see if you are worthy)

Where do you live? Oh, there? Check.

Gobs of money, Check., (nice Bentley in the driveway, by the way).

Charitably inclined, Check.

Okay, so who do you know? No kidding…Check.

Well, I’ll tell you what. You got a million to invest? Why don’t you start with $200,000 and we’ll go from there. See if we get along, okay? Yes, yes, yes, you’re welcome–don’t mention it.  I’m happy to do a favor for one of our kind.”

From all accounts, these were the conversations going on in exclusive hotels and country clubs around the world. The person talking is Bernard Madoff (Bernie to his friends) and his minions. This is a small part of the story that is unfolding as the days pass by. The story of the largest Ponzi scheme in history. $50 billion dollars of history.

It is said that Steven Spielberg was an investor with Madoff. It would seem that he had a close encounter of the 3^rd kind, which, by definition, is direct contact. I, on the other hand, had a close encounter of the 1^st kind, which is a sighting of odd lights and objects not attributable to human technology. My sighting came 10 years ago, when a CPA asked me to comment and review the returns of a very successful money manager. One of his clients was very excited by the possibility of investing with this manager. What bothered the CPA and subsequently bothered me, was the questionable consistency of the returns. Records showed gains of 10-15% per year; year in and year out. Not a single year of negative returns. I looked over the material and stated bluntly that this was not possible, and I advised him to pass on this. Luckily, he did.

This, for me, was a simple observation. I had never seen or heard of anyone who could invest like this, and having read many books about the world’s greatest investors, I knew the basic rules of the stock market, one of which can be explained by the following metaphor: “If you’re in a boat, and the boat is in the water, when the tide goes out, you have to go out with it”. In other words, if you are invested in the Stock Market, it is impossible to get in and out of the market consistently and successfully over any long period of time. Because of the laws of financial physics, it is impossible. Like gravity, what goes up must come down.

How did so many people get fooled? Everyone is asking themselves the same question. How could so many people entrust their entire savings to one person? Even a few professionals were fooled and they should have known better. Professionals know how to diversify appropriately. They know that one manager, even with very good investment results; will lose money at some time. It takes a well diversified portfolio to protect you from this fact. Diversification prevents these types of devastating events. Interestingly, Madoff made no pretentions to diversification. He had one strategy, and that was his secret. It is reported that he freely told investors that he would reveal how he invested the money and it seemed a matter of pride. No one could do it like him and because he did it for so long, everyone believed him.

What can we learn from this? Madoff’s strategy could have been considered hypnotic. According to Laurence Leamer, author of “Madness Under the Royal Palms”; if Madoff handled your account, you could boast about having the largest financial gains to your friends. It was an honor if Madoff managed your money. He had the Midas touch. Madoff was a God.

How did he succeed for so long? How did he pull this off? To answer this, let’s examine the psychological reasons he succeeded. I’m not a psychologist, but I have my own ideas.

First, he was smart enough not to publish or pretend he had made the highest returns. If his fund was rising 28% per year for 10 years everyone would have been suspicious. He just promised 10%, a very reasonable return. After all, hasn’t the stock market risen at an average rate of 10% for the last 80 years? Most people don’t realize that the term: “average return of 10%” is very misleading. Here’s why. It is said, “If you have your head in the freezer and your feet in the oven, you’re average temperature is 98.6 –but you’re dead”. Or “The average temperature in Dallas, Texas is 78 degrees, but it’s 110 in the summer and 25 in the winter”. You see, it’s misleading. Some years the market can rise by 10 and 20% and in other years it may fall by 30%. The average may be 10%, but the sequence of these returns can really hurt you if you’re not prepared. Madoff’s trick was to use consistency as his lure. This is an old sales technique called the “Puppy Dog “close and I want to thank my friend Bob Irish for this one.

The “Puppy Dog “close is used by pet stores to “help” you make a decision to buy a puppy while you’re already in the store. The salesperson knows the decision to buy a dog is a big one. It’s a big commitment to care for a puppy for many years, and it may give you pause. To make the decision easier, the salesperson breaks the purchase down into smaller increments. This allows you to make a small decision instead of a large one. Instead of just buying the puppy, the salesperson suggests you just take it home for a little while and if you don’t like it, bring it back. He knows that once this dog licks your face and starts playing with you, you’re probably NOT bringing the dog back! It’s the “Puppy Dog” close.

Once Madoff’s new investors became involved and got a taste for those steady returns, they were not going back!

Madoff’s club was an exclusive club. You may remember how it felt to be excluded from cliques in high school and how good it always feels to be a part of something special. That is how it felt to invest with Madoff. You were a part of something special. If you had Madoff, you were special. Investors didn’t investigate Madoff before they invested, he investigated you! What a brilliant switch!

He took advantage of our love of celebrity culture. We love and admire our celebrities and endow them with major powers and gifts of insight. If it was good enough for Steven Spielberg, it’s surely good enough for me. Steven Spielberg is a movie making genius, but does that make him a savvy investor?

Finally, Madoff was using what is now referred to as viral marketing. This is the same as word of mouth, only stronger. Viral marketing is a technique that uses pre-existing social networks to produce increases in brand awareness. You know, you tell two friends and they tell two friends etc. This is very powerful stuff and very hard to resist.

So what should you do if you are presented with one of these too-good-to-be-true investment schemes?

Use your good sense. YOU do the due diligence–it’s your money. Do your homework. Don’t take someone else’s word for it. Try to keep your emotions out of it, and remember Groucho Marx’ famous saying: “I won’t belong to any club that would have me as a member”.

If you give your money to a manager, make sure he is not holding the money in his own brokerage account, or that your money is not comingled with others unless it is a registered security. If it’s not registered, have a securities attorney look over the documents. Also, it is preferable that the money sit at an independent firm, a firm that is separate from the manager.

Finally, know what you own. Look for diversification. Diversification will protect you from a lot of serious mistakes made by investors. Stay vigilant. You have worked very hard for your money, so make sure the person managing it, respects it as much as you do.

A Year-End Synopsis and a Not-So-Close Call with

Mr. Ponzi.

We are approaching the end of 2008 so it’s time to look back and make sense of what happened. It is also time to look ahead to possible opportunities on the horizon.

Before I begin, however, I want to relate a personal experience to you that has become news this week. In 2000, I received a call from someone looking for help in investing a friend’s money. Then, like now, the market was declining and his friend had experienced some significant losses. I took the portfolio and fashioned it, as usual, for growth and asset preservation.  

The person referring his friend was using a money manager that showed consistent returns year in and year out. I’m talking 10% returns, no matter which way the market was moving. Every year his portfolio would rise by about 10% with never a down year. I knew this couldn’t be true, so I asked for the statements and trading reports to see what was going on. I spent the good part of the week studying the material, but couldn’t find anything suspicious. The manager was trading in and out of positions on very specific days, making regular profits but there was nothing incriminating on the reports.

This manager, by the way, was very well known on Wall Street as a major Market Maker for many important stocks. A market maker is a company whose function is to aid in the market, by making bids and offers for his own account in the absence of public buy or sell orders. In other words, it’s a company that is very involved in the order flow from investors around the world. I chalked his performance up to the fact that he was so involved; he could get in between the flow of buy and sell orders.

Of course, I couldn’t come anywhere close to these types of smooth consistent returns and eventually the client left as he was able to convince this money manager to take his friend’s account. 

Last week it was revealed that this manager’s name is Bernard Madoff and he is accused of running a $50 billion Ponzi scheme. This is the largest fraud I know of using a Ponzi or pyramid scheme. The scheme involves using new investors’ capital to give old investors a return on their investment. This pyramid works well until there are no new investors to entice, or old investors start asking for their money back. This seems to be exactly what happened. Investors, spooked by the market asked for $7 billion of their money back and the manager was unable to pay. Madoff confided to senior people ( his sons, apparently) that he had been running the Ponzi scheme for many years and he was broke. I heard about this from a CPA whose client has $12,000,000 in the fund. The CPA’s client was the person who had come to me 10 years ago. He lost it all, I understand.

I think you all know the lesson here. If it’s too good to be true then it’s probably a scam. I feel very bad for anyone involved in this type of scheme and any “I told you so’s” don’t help anyone, but I have seen this so many times in my years, that each time it happens I’m still surprised. These schemes ALWAYS lose in the end. They have to. It’s a law of financial physics. There is always a trade off. It’s important to note, if you are looking for higher returns and have placed your money in the stock market, real estate market, gold, currency, oil etc.; you are always assuming some risk. If the risk has been abated, then the return has to adjust as well. There is no free lunch.

Let’s continue with my commentary, and look at the numbers through December 12, 2008   For the month through December 11^th, the Dow is down 2.99%. For the year, the Dow has decreased 35.43%.From the high reached on October 9^th, 2007, the decline has been 39.53%. The S&P 500 has decreased 44.18%.  

These are horrific numbers. It took the S&P almost 3 years to lose 40% between 2000 and 2002. This time it has taken less than one year. From the high on October 9^th, 2007 to the low on 11/20/08 the market declined 52% which was the third worst ever. The number 1 and number 2 declines took place in 1932 and 1938, down 62% and 54%, respectively. There were 5 other declines greater than 40%, 4 took place in the 30’s and 1 in 1974.

Bespoke Investment Group, provided these numbers, and they feel we are now in a bull market, as hard as that is to imagine. They define a bull market as one in which there is a 20% rally after a 20% decline. They believe the bottom of the market was the November 9^th, at the 7,500 level on the Dow.

Whether we are in a bull market or not, the technical reading for the market still shows no signs of an imminent recovery just around the corner.

Finally, are there any opportunities for high returns in 2009? The answer is yes, a few good ones are taking shape. Two are in the bond market and one is a complete surprise.

Bonds

The two opportunities in the bond market are associated with good quality and low quality corporate bonds. 

Normally, to measure corporate bonds’ risk/reward, you look at the difference in the yields as compared to treasuries. This difference or spread is currently well above normal due to the credit crisis. A normal spread is 2-3%, today the spread is 5-7%. This means you are getting paid a lot of money for the risk you are taking.

High Yield bonds are yielding even more. The spread between “junk” bonds and treasury bonds is at a historic high of 12%; i.e. high yield bonds are currently paying 15 to 20% while treasuries are at 2.5%. This spread pays you very handsomely for the risk you are taking.

Now the surprise. An asset class that is currently undervalued is Real Estate. As a matter of fact, the shares of home builders have increased 30% from their November 20^th lows, so something is going on here. Real Estate Investment Trusts, which invest in all types of Real Estate, from residential to commercial properties are now paying dividends of 6-9%, as investors worry about office building vacancies in 2009. It is obvious that commercial real estate is under pressure from the slowing economy, but once again, you may be getting paid for the risk. There is no hurry to act on any of these items so I will be buying these investments discriminately as the opportunity arises.

Can Fear Make Us Better Investors?

It’s an investment dilemma. In tough markets, investors are sometimes wracked by fear and anxiety raising the question; Are either of these emotions helpful? 

Feeling fear can be a healthy response to real danger for which you can prepare a plan of action. For example, if you meet a bear in the woods, this is a real danger which is accompanied by fear. As the cowboy stranger so rightly said in the “The Great Lebowski”, one of my all time favorite movies, “Sometimes you eat the bar (sic), and sometimes, well, he eats you.”

The fear we feel when confronting the bear is real and can be handled with a series of actions and a lot of praying. You don’t chase or approach a bear at close range. You shout, wave your arms, bang pots and metal objects. You stand your ground hoping the bear will go away sooner or later.

Feeling anxiety over the possibility of encountering a bear could cause you to exaggerate the danger, and lead to irrational responses like forever avoiding the woods. 

In today’s modern world, the chance of meeting a real bear is unlikely, but a type of bear that investors will always encounter is the bear market.

Which emotion does a bear market instill in you? Fear or anxiety?

If you are feeling fearful, you can take appropriate action:

1.      Identify the fear. If you have a fear of losing your money permanently, examine your portfolio. It is important to assess whether the failure of any one investment would irreparably harm your overall wealth, or simply reduce your future rate of return.

2.      Formulate a plan of action to respond to real danger. For example, you can sell the stock, and make sure your remaining investments are well diversified. Mutual funds or index funds are a good way to diversify. Healthy fear. Healthy reaction.

If you are feeling anxious, consider the following:

You may have already diversified your portfolio, but continue to remain overly anxious and tempted to sell everything. This unwise move may cause permanent damage to your future security. It is an irrational action created by anxiety, not fear. Try to keep the big picture in mind remembering that markets and economies are always cyclical. 

Extrapolation

Definition: The taking of recent current events and projecting them into the future.

I once read that in 19^th century London a magistrate complained that in the not too distant future the growing number of horses would create unbearable health and traffic problems. The city would be overrun with filth and disease. This person was extrapolating the current horse population straight out into the modern era, without any knowledge of the changes that would take place just a few decades later.

In 1999, stock prices had been going up double digits for 4 consecutive years. Everyone was talking about the stock market and many were jumping in for the first time thinking that investing was easy. The media paraded a number of gurus who declared the “death of the business cycle” due to the invention of the internet. No doubt the internet has significantly changed our world, but it has definitely NOT abolished the business cycle.

In 1999, two internet companies with NO earnings, CMGI and Internet Capital Group (ICGE) were worth more than the combined value of:

• International Paper
• Alcoa
• GM
• Honeywell
• AT&T
• Eastman Kodak — Remember, I said combined!

 Back then, CMGI traded at $163 and ICGE traded at $212. Today they are $3.72 and $3.85, respectively.

In 2002, after 3 bloody years of declining stock prices, most pundits and investment fortune-tellers forecasted more years of stock price declines. The Dow fell to 7,286 and many were saying it was going to 5,000. A Dow of 5,000 struck fear in my heart, I confess, but I did not react to my anxiety. Just one year later the Dow was at 9,617- an increase of 32%.

In 2005 I gave a speech to the American Association of Individual Investors, and asked this question: “If bubbles occur because of constantly rising markets, what market are people most bullish about right now?”

The answer back then?  Real Estate, and we now know the danger of extrapolating a continuously rising bull market in Real Estate. It’s the disaster which haunts us now.

Let’s come back to the present day. In 11 months, this bear market has done the same amount of damage which took 3 years to accomplish in 2002. Like then you will now hear gurus and fortune-tellers parading around telling us the world is going to hell in a hand basket and prices will continue to go lower. That’s not to say that prices won’t continue to decline. No one can really say,….but don’t forget they have already come down a long, long way. There is an old saying for bull markets: “Trees don’t grow to the sky”. Bear markets aren’t a bottomless pit either so don’t make the mistake of extrapolating the recent declines to zero.

As a matter of fact if you can turn your thinking around and contemplate the idea called “reversion to the mean”, you may start to become very successful at the investing game. Reversion to the mean suggests that prices and returns eventually move back towards the mean or average.

Like a rubber band that stretches but will eventually bounce back, mean reversion suggests the same thing for stock prices —and the longer the rubber band is stretched, the bigger the snap back. This idea can give you the courage to enter this market even if it declines further from here.

Stock prices are already down 40% since the beginning of the year. I suppose they can go down a lot more, but that seems highly unlikely. Investing in the market now will have a higher likelihood of success at today’s low prices than investing when prices were much higher. At some point business will begin accelerating again and stock prices will jump quite high. To quote Warren Buffett, “Be greedy when others are fearful and fearful when others are greedy.”

Learning to avoid extrapolation, while understanding the difference between fear and anxiety, can make the difference between creating substantial wealth or losing it.

The Double-Bind

The mother says to her son: “Come here, darling, why don’t you come and kiss Mommy? You never kiss Mommy.” As the child comes the Mother stiffens and freezes. When the child stops, confused, she says: “Come darling don’t ever be afraid of expressing your feelings.”

A wife laments that her husband never brings her flowers spontaneously and she tells him so. He is in a double-bind. If he brings her flowers, it’s not being spontaneous, if he doesn’t, her accusation is correct and he can’t please her.

It’s a “damned if you do, damned if you don’t” situation.

The most famous double-bind comes from the book Joseph Heller’s Catch-22. Here’s a taste.

 Your broker, advisor, or radio personality tells you to hold onto your stocks in a terrible, terrible market. He says; “Stocks beat all other investments in the long-run.” As a matter of fact, he points to many very successful investors and says: “They are buying now, not selling. He tells you that calculations of future returns for the stock market in 10 years call for a likely 10-12% rate of return. He asks: “Do you really want to sell everything now that the market has fallen to such historically low levels? You grit your teeth and hold.

Yet, each day you are tested. Each day you see your investments fall in value. The news is bleak and you are afraid to look at your monthly statement. If you do, you feel nauseous.

You’re in a classic double-bind. Caught between your desires to earn a high return and avoid your past mistakes of selling out of fear.

It’s a double-bind. Damned if you do–damned if you don’t.

The Way Out

So what do you do? How do you get out of this dilemma?

One of the first rules of getting out of a double-bind situation is to realize that one person or entity in the relationship is the so-called “power person”. It is usually the one presenting the double-bind, whether it’s the Mother, the Wife, The Army or your broker. They are setting the limits of the discussion putting you in this double-bind situation. So firstly, you need to understand who this “power-person” is.

Secondly, you have to make up your mind to determine what you should do. If the child was an adult, he could say: “Why do you recoil from me when I try to kiss you? How can you expect me not to be confused when your words and actions are different? This way, he regains his power back in the conversation. The husband could take on more power by saying: “I don’t bring you flowers, but I do other things, spontaneously and from my heart.”

To your broker or advisor: You have decided to give this person whom you trust, the power to guide you and make some important decisions for you. You have decided to give up some power and follow the professional’s guidance. But you still have to have the power. You should ask yourself if there are any events of reasons that have diminished your level of trust. I’m not talking about predicting the market’s decline. No one can consistently do that correctly. As a matter of fact, the best investors don’t even try. But is your advisor meeting with you through these tough times? Is he or she taking your call and explaining as many times necessary, why you are invested in “this or that”? Is he acutely aware of your emotional risk tolerance? Are you confident that despite the markets weakness, your total portfolio is basically sound? If not, you have the power to change and break the double-bind.

What about your humble radio advisor? Should you follow what I or any other TV or magazine guru has to say? Do you want to give your power over to a person that has to speak in generalities to get a point across? No.  Take in the info, feed it through your logic, learn a little more, talk to others and get your own view. Ask your advisor to comment on these questions. Any good advisor will take other’s words and thoughts into consideration.

What about my original challenge to break the double-bind? The challenge was: “Hold on and watch your investments decline in value, or sell everything and get out of the market entirely?”

It’s in your power; there is no real double-bind when you know what to do.  Do you really think you’re problems will be solved by buying CDs at 4%? If so, do it and don’t look back.    

Is the current value of your portfolio, as dismal as it is, having an effect on you right now, other than emotionally? If not, why the panic? If you can be sure of anything, what goes down will come up eventually. No one’s life and no market experiences wonderful times exclusively. 

There are always the bad days, months and sometimes even years. Can you wait? Can you “tough” this one out? If so, stay in. invest on dips and don’t look back.

 Make your decision. Stick with it and get out of your double-bind.   

 Get your power back!

Are CDs The Right Investment Today?

 

Everyone is talking about safety these days and many people are looking to money markets (now that the Fed is behind them), Treasury Bills and CDs for the safety they crave. These have become the investments of choice for many of the fearful. I have even seen statistics showing a large increase in the sales of in-home safes (I suppose it’s today’s equivalent of putting your money under the mattress) as people run for cover when the markets go down.  When things are good, they start following the crowd once again and reach too far for investment return. I’m sorry to say I have seen this reaction time and time again in my 28 years. Why does this happen? In my view, it’s the way many understand the term “risk”. There are different types of risk and investors tend to focus on the wrong type. Here’s what I mean.

 

What if you needed to go from New York to LA and wanted to do it in the fastest, safest way? What would you do: Would you fly? Take a train? Drive? Without delving into statistics and with a little Google research, I’ve discovered what most people know; flying is the safest, fastest, followed by train followed by car.

 

Now let’s talk fear and perception. When you get into your car, all four wheels are on the ground, you’re in control surrounded by a seat belt and air bags to boot! You FEEL relatively safe. There is no turbulence and you point the car and go. You feel safe and you are willing to give up getting to LA quickly, with the notion that you will get there more safely.

 

When flying, you have the same seat belt (a lot of good it would do!) and a huge machine under you pulling 120,000 tons of weight into the air. You may feel nervous at take off, I know I do, and the flight may contain numerous bumps and ups and downs as the plane adjusts to atmospheric conditions. You may even feel a little air sick because of the turbulence. And yet…it’s the fastest and statistically the safest mode of transport.

 

How do we define safety? Is it the turbulence you experience? Or is it the fear you feel because of it? Shouldn’t it be the ultimate goal of getting to your destination safely? No one thinks air travel is safe because there is no turbulence; it’s safe because more people arrive safely per mile travelled.

 

When you look at the two modes of transportation, by air or by car, air travel wins by a large margin. It’s much safer and much faster than driving.

 

What does this have to do with investing? I bet you’re a little ahead of me. The question is: What is the fastest and safest way to get to your financial destination?  Is it CDs? Stocks? Bonds? Real Estate? Gold?

 

Here’s my take on it… Let’s start with the fastest mode and use the Rule of 72 to calculate speed. The Rule of 72 states that to find out how long it will take for your money will double, divide the rate of return you receive into 72. For example, a 10% return, will double your money in 7.2 years. At 5%, your money will double in 14.4 years. Simple, right?

Looking at today’s CDs, we find current rates to be about 4.5%. At a 4.5% rate, your money will double in 16 years. If we take taxes into account, the doubling time is 20 years. A very long time, right? Fast or not fast? Not fast. What about the ride? Volatile or smooth as silk? Smoooth…..Is this best for your financial help because of the lack of turbulence? I would argue no. 4.5% net of taxes is about 3.5%. If you consider a reduction in your standard of living a serious risk, you must take inflation into account. If inflation is 3%, then you are left with little if any left over to take income or any other benefits from your savings. This is a greater risk.

 

What about stocks? These days the turbulence is breathtaking and not a little nauseating. Down 400 points on a Wednesday up 557 points on Thursday, and no one knows what it’s going to do on any given day. In terms of safety, if you are trading this mess, it’s extremely risky. If you own a diversified portfolio that you don’t need to touch for 5 to 10 years, history has shown that the volatility of stocks over a long term diminishes. But today there is even more. Now when everyone is travelling “by-land”, meaning they are rushing to CDs in order to avoid the turbulence, current prices are indicating that stock investment returns for the next 10 years could be 10%-12%. Why do you think he’s buying along with so many other successful value investors?

 

Recently I read the weekly report from John Hussman. He is the money manager of the Hussman Funds. (www.hussmanfunds.com) and has been bearish as long as I can remember. His management style enables him to buy stocks and hedge them at the same time with various financial instruments. He has been hedged all year and his fund has held up very well.  In his most recent column, which can be found at his web site (www.hussmanfunds.com), John wrote that based on the current value of US stocks, and using normalized earnings projections going forward, he expects stocks to earn 10-12% over the next 10 years. Yes, this is prediction like so many others (everyone has an opinion don’t they?), but at the very least, his is based on level-headed, established mathematics and proven experience in the real world. Not on emotion, hearsay or the desire to sell you a quick road to riches. He also says that volatility (read turbulence) is going to be high. So he’s still keeping part of his hedges.

 

A 10% return means 7.2 years to double. 12% is 6 years. These are predictions, not guarantees or facts, but I think it’s high quality information to help guide you forward.

 

Decent quality Corporate Bonds are yielding 6% to 8% these days. Some volatility, some uncertainty, but in my opinion, definitely a rate of return which pays you for these attributes. 6% doubles in 12 years, 8% in 9 years.

 

So the point is: are CDs the fastest and safest? Not even slightly, in my opinion. Not the fastest, nor (relative to inflation), the safest.

 

Stocks are fastest and if we define risk as the probability of reaching your destination in 10 years, the safest.

 

Bonds are faster than CDs. And (inflation adjusted) safer. —More like taking the train.

 

So what do you think? Are you ready to take be more courageous by not allowing the turbulence to dissuade you from getting to your destination with a higher probability of a safe arrival? Or are you going to be lured into the seeming coziness of your comfy car thinking your safe arrival is assured (when statistically, it’s not)?

 

I guess it depends how you define safety. I know how I define it, how about you?

America is Amazing.

America is amazing. 100s of years of racial strife and struggle have all been turned on their ears on one date, a fateful and historic date of 11/4/2008. It sort of makes one wonder how such a milestone could have been passed with such seeming ease? One minute, the idea of electing a woman as President seemed barely possible, but the thought of electing an African American? It would have been unthinkable just a year ago. America is amazing. Congratulations to us all. Whether you voted for him or not, Congratulations to us all.

So what now? The market’s reaction to his election was not very good as the market sold off about 10% in the following two days. Truly, what can this man do? What can any man do under these circumstances? We know that he will have to hit the ground running even before his inauguration.

First, with George Bush’s approval, the congress should pass another stimulus bill as a down payment of more to come after the inauguration. This stimulus, if not paired with deficit reduction, will create the biggest deficit in history. The issues will be challenging.

The early consensus indicates that the stimulus bill will be geared toward direct checks for consumers, a tax credit for job creation and spending on public works such as school repairs, roads and bridges.

After the inauguration, Obama has proposed investing $150 billion over 10 years in clean energy plus a fund to invest in manufacturing research, new job training programs and an infrastructure investment bank.

He wants to temporarily suspend the rule which requires seniors to take required annual distributions from their retirement accounts at age 70 ½ and give a temporary tax credit of $3,000 in 2009 and 2010 to companies for each new full-time employee they hire in the United States.

Proposals include requiring financial institutions participating in the bailout to put a 90-day moratorium on foreclosures for homeowners acting in good faith, plus lending to state and municipal governments facing budget crunches due to the mortgage crisis. 

Taxing Wealth 

With regard to income taxes, Obama has stated many times that he wants to raise income tax rates on those earning over $250k joint and $200k single to their pre-2001 levels of 36% and 39.6%. Currently they’re 33% and 35%.

Social Security taxes could also rise for high income earners. Currently, if you earn over $102,000 you are no longer required to pay social security tax. This would continue for those who earn from 102k to 250k but would rise by some number for those earning over $250,000.

The Social Security tax is already 12.4%. You and your employer each pay half. We don’t know what the rate for those making over $250k will be at this time; hopefully those paying more will get some extra benefit for their investment.

It will be interesting to see if these added taxes will be a burden to the economy. If you live in states like NY, Pennsylvania or California and you are taxed at the 39% rate, add in the extra cost of state and city tax plus extra SS tax and the government will be taking well over 50% of your salary.  This will not spur investment and spending. We’ll have to see if this slows the economy even more.

First things first, expect some year-end selling as investors take advantage of this year’s lower capital gains rates.

Investment wise, there may be a shift toward infrastructure and health care stocks due to Obama’s longer term goals. Right now President-Elect Obama will need to clarify his short-term positions on a range of economic issues in order for the market to stabilize and get a more solid footing.

At the very least, what we want to see immediately is a market more focused on fundamentals; a market that can price securities relative to their perceived future value taking interest rates, inflation and the prospects for world growth into consideration. At that point we will see money managers have more control over their performance numbers. Right now only those managers who have their money in cash or have shorted the market are doing okay. Cash and speculation are not a long-term solution and those managers that own stocks and manage conservatively will do considerably better over time.

We’ll continue to keep you informed.

Get Your Power Back!

Feeling down? Market making you nervous? Are you suffering from the anguish of mental neuritis and emotional neuralgia just because the stock market refuses to go up? Is your anti-perspirant and anti- depressant not holding up under the strain?

Then you need some relief. Relief that can only come from a combination of uplifting stories of famous investors who have thrived in markets like these. Investors who have been around the block so many times that this time around seems like just another trip to the the candy store for them.

I’m not talking about antidotes, I’m talking about anecdotes, I’m talking about stories of the great investors. Stories of courage and perseverance. Stories of personal triumph overcoming all the odds.

I’m talking about the greats from Warren Buffett to Jim Rogers. From John Templeton to Napoleon Hill, the author of “Think and Grow Rich”.

This is the true medicine and it’s guaranteed to help you get your power back. That’s what I’m talking about today. Get that pep back in your step and give you the courage to actually open your monthly statements with a smile. 

I’ll say it again, great fortunes, whether new or a continuation, all begin with markets just like these.

Let’s start with our Napoleon Hill.

•  “Every adversity, every failure, every heartache carries with it the seed of an equal or greater benefit.”  

Failure: let’s deal with it. One of Hill’s biggest findings was that before people achieve success, they must first find themselves on the brink of failure. Say this one again, out loud: “Every adversity, every failure, every heartache carries with it the seed of an equal or greater benefit.”

• “Opportunity often comes disguised in the form of misfortune or temporary defeat.”

Stay on the look out for opportunities. Keep your confidence and be alert to opportunities.

• Don’t join the quitters. The key word here is “temporary.” Defeat is temporary unless you help make it permanent. No matter how difficult things may get, “this too shall pass.” Make sure you don’t fall into the all-too-common trap of becoming paralyzed by inaction. As long as you are willing to get back up and fight another day, failure is only a temporary condition. Never give in!

How about Warren Buffett?

Consider his recent statement on Friday, October 17, 2008, in the New York Times:

“I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.“

“It’s only when the tide goes out that you can see who’s been swimming naked. What I think this means is “Know what you own and use conservative analysis to reduce the amount of mistakes you may make because the future is uncertain.”

“A group of lemmings looks like a pack of individuals compared with Wall Street when it gets a concept in its teeth.” —Warren Buffett

“People’s investments would be more intelligent if stocks were quoted once a year.”
—Warren Buffett

John Templeton

There was a man who borrowed money in the 1930s to buy 124 U.S. stocks for under a $1 apiece. He bought all of them he could find with the hope that a small percentage of winners would more than make up for the slew of losers that were likely to come. His name was John Templeton, the Templeton of Franklin-Templeton Funds. Before the merger many years ago, the Templeton Funds were famous for outstanding performance and conservative investing style. John Templeton is considered the father of the mutual fund by many.

“To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude, even while offering the greatest reward.” —Sir John Templeton

Jim Rogers, Arbitrageur and financial editor says:

“The smart investor . . . learns to buy fear and panic and to sell greed and hysteria.”

Daniel Drew, notorious stock market speculator, found from notes in his trunk after his death in 1870:

“The way to make money on Wall Street . . .is to calculate what the common people are going to do, and then go and do just the opposite.”

—Paul Samuelson, economist

—Peter Lynch, very successful manager of the Fidelity Magellan fund.

—Bernard Baruch, famous financier, investor and confidant of presidents

—Winston Churchill

“A kite rises highest against the wind, not with it.”

These are some smart words from some very smart people that can help you get your power back. Sorry that I mislead you by promising fast acting relief for your emotional neuralgia (what ever that is) and I hinted at the likelihood that a simple pill would solve your problems. There is no pill and this is not easy to do. That’s why so few get it right. But you CAN get it right if you get your power back. These ARE the times when future fortunes are made.

—and even though the blood running in the streets today may be yours, Warren Buffett, John Templeton, Jim Rogers,  Bernard Buruch, all made their fortunes in times like these.

It’s your turn now.

The markets continued their up and down rollercoaster last week as pundits and investors tried to figure out why this or that was happening.

It was a big case for: “one man’s ceiling is another man’s floor”. I’m talking about oil in particular. Last week oil hit $68 per barrel, ending slightly over $70. So why is the media so quiet? When oil was $145, everyone was screaming about the terrible effects on the economy. These days the media is so preoccupied with the “bailout” story, oil is barely mentioned. Oil is trading at a 14-month low potentially saving the economy an estimated $330 billion (every decline of $10 saves $70 billion). So let’s take a look at a wider picture and figure out how the media shapes our thinking.

In his book The Black Swan, Nassim Taleb describes the condition that no matter what is happening in the market, a seemingly plausible reason is always given. Last week for example, Gold fell $40 per ounce. Why? Are central banks selling? Are investors no longer worried about financial Armageddon? Did inflation disappear? Is this what drove investors to sell gold? We heard all these reasons for this large one day selloff because we are always looking for the reason for things. It’s human nature. But you know what? No one really knows why. Sometimes when asked why the market rose or fell, I kid around and say: “more sellers than buyers” or “buyers than sellers”. But the fact is: that is the only reason one can know for sure why investments rise or fall.

Take those lowly pools of mortgages that seemingly started everything. The general consensus among experts is that these pools will pay back the majority of principal, there is just tremendous uncertainty about exactly how much and when. For lots of reasons, buyers have stepped aside because they are afraid. This leaves the sellers in charge. When sellers are in charge prices drop. When there are NO buyers, prices collapse. These days, prices are collapsing a lot in many markets because everyone is afraid to buy. So why have mortgage prices collapsed? Foreclosures? Worries about the economy?  Greedy bankers?  Sure. Take your pick. Prices have dropped because sellers are in charge right now.

There is no doubt that during the week ending October 10^th, sellers had the upper hand. So much so, that it seemed like a panic. Buyers had to step away. but, as is often the case, buyers are showing more interest and have come back to the market.. Even to say that buyers and sellers are about even causing the market to have a slight upward bias. This is better news.

Forget the reasons why, it’s all about buyers and sellers.

The same thing happened in the bond market. There has been so much fear (so the media says) that investors sought the safety of U.S. Treasury bonds. The yield on one month t-bills dropped to .05%. You might as well put your money under the mattress. That’s how scared everyone was.  

Key lending rates had also spiked because sellers were in control. That has eased too. This is better news.

So the lesson here is don’t focus on the reasons these things happen. Like the reasons given for the original spike in oil, no one knows why prices spiked. They’ll say it was tight supply or point to fantastic projections for future growth or blame the speculators. Maybe those are the reasons. Maybe yes—maybe no. But I can tell you one thing. It’s was more buyers than sellers but now the reverse is true. Sellers are in control. Is it because of the fear of recession? Are Hedge funds selling out to pay for other bad investments? Is it the speculators again? Maybe yes…. maybe no.

Just more sellers. That’s all we can say.

Summary: 

Someday in the future, someone will study what happened and we will have our answer (we probably won’t care because we’ll have another set of perceived problems). In the meantime, the lesson to be learned is: you don’t need to know “why” to be a successful investor. You just need to know who’s in charge, buyers or sellers.  

So, don’t buy a word of the “why”. You don’t need to know the “reason” to create a successful investment strategy, so, don’t make it part of your investment strategy.

Good investors know that the truth is far harder to come by and to a large extent, unknowable.

Just understand what you own and stay clear of the reasons why. Creating wealth is reason enough.

What a wild ride. Nothing like it has ever been witnessed. Nine months worth of bear market decline took place in just two weeks. Was this just an emotional sell-off, based on fear or was it a foretelling of a future of impending doom?

Let’s look at the cycle of market emotions. I have been saying since December to be cautious. Don’t sell everything but don’t chase the market either. Keep some money in cash, diversify and know what you own. Good words, the right words, but based on last weeks trading, the wrong words, at least temporarily.

You see, there is a great unwinding of credit all over the world. Investment companies that were borrowing yen in Japan, at near 0% interest were buying assets of other countries and making money hand over fist. Now that those investments have declined, they have to sell to pay off their loans and a downward spiral is created around the world.

Add to this the degree to which the central banks have had to intervene to keep the financial community afloat and the uncertainty has brought even more sellers into the market; and, it seemed last week that there was no end in sight.

Most of the selling is from the big players in the global market. What about you and me; the little guys?

What are you doing? Are you selling you’re stock funds in your 401k? Stock fund money managers see the flow of buy and sell orders throughout the day, and they will sell securities to meet those redemptions. This means even more downward pressure on the stock market adding our little bit to the spiral.

There is so much panic selling now, that only a very few are stepping in to buy. Who are these people who are buying now? Is it you? Probably not, right?

Of course, every time you sell a stock, someone is buying it. Do you ever look at the historical prices of a security you were considering for purchase? The stock you’re looking at for example, is now priced at $40 but sometime in the last 20 years the stock was just $1.50. Ask yourself: Who was it that bought this and how did he or she get this low, low price? What were market conditions like at that time? Were they just like they were now?

I remember back in the early 1990’s when the market was swooning, (Remember the S&L crisis and the RTC)? The Tisch family bought a lot of stock of the Bank of New York at about $15 per share. The stock continued to decline. If my memory serves me correctly, they picked up some more at 11 but the stock continued to decline to $8. I said to myself, at the time (I was very young then) — see they are wrong they have made a mistake! Two years later the stock was at $30.

If you wonder who is buying now, when everyone is running around selling, it’s those kinds of long-term value investors who are now stepping in. Remember these are the days from which future fortunes are made.

So let’s get back to this idea of the cycle of market emotions.

Imagine looking at roller coaster from the side. The track goes up and down and up and down. Now imagine this coaster is your emotions. When you start up the first hill, you are feeling a little anxiety but if you’re like me, excitement is building. Going back to your investing strategy, maybe your 401k is rising every month and you can literally see yourself get richer by the day. You become more optimistic and put more money into the market and if your advisor has suggested the same, he or she looks very smart around this time. If this goes on long enough, you are really feeling great. Confident, optimistic, even euphoric as all your recent decisions have been right. You’re feeling smart, very smart. You may even decide that you are so smart that you put all your money in the market or maybe get aggressive and buy the latest and greatest darlings of Wall Street.

But guess what. Nothing lasts forever and the market starts to go down. You feel some anxiety, but remember that the last time this happened it was a little sell-off and the market rose again. Only this time, it doesn’t happen. It begins to fall more. Your anxiety turns into fear, but, you tell yourself, “You’re a long-term investor” and will hold on.

But the market continues to decline. Now your feeling that holding may have been a mistake. The newspapers are talking seriously about recession with possibilities of depression, and selling is rife. Now you’re getting desperate. Why didn’t I sell before? Why didn’t my broker tell me to sell? Maybe I know nothing, but he or she is supposed to know! Then, ouch, a few really nasty days take place and you become terrified. Maybe it is the end of the world? Maybe I’ll never get to retire? Maybe those that are saying “sell if you have to retire in 5 years” are right. Do they know something I don’t? You call your broker and tell him to sell, sell, sell. Sell at any price; Sell everything no matter how good it’s supposed to be, just put me in a safe place until this terrible storm blows over.

Whew………-back to the rollercoaster.

You have just been on the 300 foot drop and you thought you were going to die. You negotiated with God and promised never to do this again. Back to the market. The market starts rising again. But you’re not gonna get suckered into buying. Oh no. never again! But the market continues to rise and your 401k is looking better once again. You start to feel a little more confident. The financial news networks are telling which stocks to buy now. Money Magazine’s cover is “The Best 10 Stocks to Buy Now” and you put in your toe; you call your broker for a recommendation. You are feeling more optimistic, more excitement and you are feeling smarter once again. You have just been through the Cycle of Market Emotions.

So, what should you have done? Buy when you were most euphoric or buy when you are the most depressed? I think you know the answer. Now the question is: how are you feeling today, and can you fight your fear to buy now when it feels so scary?

Remember, someone is buying. Someone’s future fortune is being started right now.

Could it finally be yours this time?