May 2009

May 27, 2009 03:45 p.m.
Don’t Worry About Missing Out

U.S. stock indexes are about 40% above their lows of March 9. Many international markets, especially emerging markets, have returned even more. Many investors are becoming impatient to join the markets and capture whatever is left of the rally. I hope they will refrain from joining the herd.

The 40% gain from the lows sounds impressive. But let’s look at it from different perspectives. The market indexes still essentially have a zero percent gain for the calendar year. The gains since March 9 merely offset the steep losses of January and February. The major indexes still are about 40% below their highs reached in the fall of 2007. From these longer-range views, this looks like a simple bounce back rally from very depressed and oversold levels. There is no indication yet we will be able to break out of a trading range.

Keep in mind the markets declined quite a bit after reaching those highs in 2007, though in the fall of 2007 many people believed we had put the mortgage crisis behind us and were ready for another upward leg in a bull market.

Stocks no longer are cheap. At the March lows one could argue that stock were very cheap. The argument, however, depended on what measure of earnings or other value you used. Today, you really cannot argue that stocks are cheap. The best you can say is they are fairly valued. If trailing earnings are used, the Dow is trading at a P/E of about 40. The S&P 500 has a P/E of about 17 based on estimates of 2009 earnings.

The beginnings of the rally clear were short sellers covering their positions. The returns after that probably were due to momentum traders. There simply isn’t a lot of foundation to the rally.

Stocks can rise only as earnings grow. Earnings growth does not look very strong for the next year. Many of the firms that beat earnings forecasts in the last quarter did so by cutting costs. Revenues in many cases were below forecasts.

The fundamental problems in the economy have not been fixed. The disaster scenario has been avoided by the Federal Reserve’s actions. The financial system is not likely to collapse. But profit margins are not set to return to the record levels of a couple of years ago. Unemployment continues to increase, hurting incomes. The housing problem still does not appear to be at a bottom. Economic growth might not be negative for the second half of the year, but for the year and into 2010 growth will be belong the long-term average of 2.5% annually, and at least that rate is needed to prevent unemployment from increasing.

For those worried about missing out, consider some research from Theodore Wong, published at www.advisorperspectives.com.

Some widely cited data show investors achieve low returns if they miss only the 10 best trading days of each year. Wong looked at the full picture comparing returns from missing both the best and worst days of the year using data for the past 137 years.

Using monthly data, a buy-and-hold strategy over the period netted 8.6% annually. Missing out on the best 24 months of the period reduced the return to 6.4% annually. But avoiding the worst 24 months increased the return to 11.5%.

Using daily data from 1942, buy-and-hold nets a 10.0% annual return, and missing the best 50 days reduced the return to 6.1%. Missing the worst 50 days, however, increases the return to 15.2% annually.

Even more important, Wong found that missing both the best and worst days over any of the periods increased the return over buy-and-hold.

The data seem to prove a point we have long made: Successful investing is risk management. It is important to avoid big losses. Reduce risk in your portfolio when valuations are high or other factors indicate there is too much risk in an asset. There will be other opportunities to earn returns with less risk.

While the doomsday scenario appears to be behind us, there still are substantial risks in the economy. That means there are substantial risks in stocks and credit-related investments. It still is best to preserve capital at this point.

May 27, 2009 03:50 p.m.
Taxes and Gold ETFs

In the June issue of Retirement Watch we review the tax rules of gold investments. Bullion investments are collectibles. But the IRS has issued a private letter ruling holding that bullion ETFs, such as IAU and GLD, are not collectibles. The investor owns shares of stock (or of a trust, depending on the vehicle). The investor does not own bullion or claims on bullion. Therefore, owning one of the bullion ETFs in an IRA will be taxed the same as stock or mutual fund investments.

May 20, 2009 11:45 a.m.
Getting Over the Blues

Americans are more pessimistic about retirement than ever. I see surveys almost daily documenting the despondency. A high majority of Americans are looking to switch financial planners or investment advisors. The annual Retirement Confidence Survey found that only 13% of Americans are very confident they have enough money to retire comfortably. The figure was 27% (its highest) as recently as 2007. Even surveys of wealthy Americans find that many incurred substantial declines in net worth and are worried about maintaining their lifestyles. I could go on quoting from surveys, but the point is made. The last couple of years have been tough on Americans and their portfolios, and that as affected their outlook.

Despite the bear market, most people are not as bad off as they fear. They have gone from unreasonable optimism and expectations to unreasonable fear and pessimism. The asset price declines are one factor causing the pessimism, and the steady flow of negative reports in the media maintain the gloom.

Let’s look at the positive side and what you can do to improve your situation.

Retirement planning has focused on specific goals: retire at a certain age; spend a certain amount each year; maintain a stated lifestyle. Those goals might not be possible after the bear market and the damage it has done to the economy. But that does not mean a person is unable to retire or will have to life poorly.

Retirement planning should be a range of acceptable goals. There should be flexibility in their plans and goals. For example, the retirement age can be a range, say from 62 to 66. The person will retire only when the accumulated portfolio provides sufficient comfort. Spending also would be in a range. If savings and investment returns are high in coming years, the higher level of spending would be feasible. Otherwise, there might be less travel and entertainment and perhaps living in a lower cost place.

You also need to consider assets other than the investment portfolio. Down the line home equity could be tapped through reverse mortgages or other means. You might have other assets hat could generate income.

Also, consider changing your portfolio so that it does not only try to generate high returns. Consider putting a portion of it in an immediate annuity sometime during retirement to generate steady income. Surveys show retirees with steady income through annuities and Social Security feel more secure and satisfied than others.

Medical expenses are a major cause of fear among retirees and near-retirees. You cannot control when you become ill and what the care costs. But you can take steps to improve your health. In addition, carefully evaluate your coverage for both medical expenses and long-term care. Consider changing coverage if that is necessary to make you more secure. Anxiety declines when people know the ceiling on their potential cost for medical expenses.

In addition, the economic and market conditions are improving. The likelihood of a deflationary depression has declined specifically because of the money and guarantees injected into the economy by Treasury and the Federal Reserve. That does not mean we will return to normal growth and activity, but it does mean the steady decline of asset prices likely is nearing an end. I am not expecting a return to normal or above normal economic growth. And there still is a lot of debt that needs to be restructured over the next year or two. But we likely will soon make some steps out of our capital preservation portfolios to add some assets with the potential for higher returns.

Above all, be flexible. Retirement planning involves knowing what you have now and making a plan to get where you want to be. You have an ideal of where you want to be, but there are a range of other possibilities that would be satisfactory. Put together a plan that is likely to take you from where you are today toward the acceptable results. If the government makes the right moves, you could very well end up in a few years better off than you today think is possible.

May 12, 2009 12:45 p.m.
What Investors are Missing

Investments, especially stocks, have been on a romp. Markets have been surging for over two months at a rate rarely seen. Should you put your money in before it is too late to join the rally?

I don’t recommend it. Too many investors are missing some key factors in the economy and markets. They are evaluating today’s situation using traditional guidelines and historic data. As I’ve said before, we are in a deleveraging economy. There is a great deal of excess debt in the economy that needs to be restructured before anything approaching normal lending and growth can return. In addition, the economy will be much less leveraged than in the late great bull market. Profits and returns simply will not be as high.

The current rally is a relief and short covering rally. Stocks probably were oversold on March 9 and do for a rise. They were pushed higher by reports that banks had passed the stress tests and would be able to raise the little amount of capital they need without much trouble. Now, stocks are overvalued. There will be some good news in coming months as economic stimulus and an inventory readjustment cause a bump in economic growth. After that, there won’t be much good news to keep investors optimistic.

The stress test did not deal with fundamental problems. Most large banks still are technically insolvent. The stress test did not require them to have enough capital to return to a normal amount of lending. Also, the minimum amount of capital the banks were required to have is low and arbitrary. Investors who view the stress test results as good news are misinterpreting them. Banks are taking advantage of this market surge to issue new stock (diluting existing shareholders by a significant amount). Other businesses are taking advantage of the rally to issue new stock and debt. This will put a lid on the rally, and this cycle will repeat each time there is a rally.

The debt overhang for both businesses and households remains in place. In the next couple of years, more homeowners will default on their mortgages. Without a significant, lasting increase in economic growth, corporate and commercial real estate debts will increase.

What will change is the Federal Reserve will be pumping enough money into the economy to offset the deflationary, deleveraging process. The result will be higher inflation and slow growth. The dollar will continue the decline it began recently.

The next couple of years will be a good time to own inflation hedges such as TIPS, gold, and commodities. It will be a bad time to own high risk debt and stocks. When we changed the portfolios in December 2008, we positioned them for both inflation and deflation, because it was not clear which trend would dominate. It appears now the Fed is willing to inflate as much as possible to avoid a deflationary spiral. It is too early to change our portfolios, but the next phase of this cycle is becoming clearer and we likely will make a few changes later this year.