How to thrive when this bear dies by Jim Jubak
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In the case of the 2000-02 bear, the initial rush after the end of the bear delivered a huge share of the 101% gain for the bull market that ran from October 2002 through October 2007. In the 16 months from the Oct. 9, 2002, low through Feb. 9, 2004, the S&P 500 gained 47%. The gains from the remaining years of the “great” bull market of the “Oughts” were rather anemic: just 9% in 2004, 3% in 2005 and 14% in 2006.
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If I’m right about the arrival of a secular bear, emerging economies and their stock markets will deliver higher returns, despite relatively slow growth, than the even more slowly growing developed economies. If I’m wrong about the secular bear, emerging economies will still deliver stronger growth than the world’s developed economies. Under either scenario, investors want to increase their exposure to the world’s emerging economies, which deliver more performance bang for less risk than most investors think.
Jim Jubak is one of my favorite investing writers. He can of course be wrong but he provides worthwhile insight, backed with research, and specific suggestions. I am also positive on the outlook for stocks (though what the next year or so hold I am less certain) and on emerging markets.
Related: Why Investing is Safer Overseas – Rodgers on the US and Chinese Economies – Beating the Market – The Growing Size of non-USA Economies – Warren Buffett’s 2004Annual Report
S&P 500 Payout Tops Bond Yield, a First Since 1958 (site broke the link, so I removed it):
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Treasuries routinely had higher yields than stocks before 1958, according to Bernstein. When this relationship came to an end, yields were near their current levels. The S&P 500 dividend yield fell 0.58 percentage point, to 3.24 percent, in the third quarter of 1958. The 10-year yield rose about the same amount, 0.6 point, to 3.80 percent.
Two explanations later emerged for the reversal, he wrote. One held that the economy’s recovery from the 1957-58 recession showed “investors could finally put to rest the widely held expectation of an imminent return to the Great Depression.” The second was the increasing popularity of investing in growth stocks, or shares of companies whose sales and earnings rose at a relatively fast pace. Because of their expansion, the companies often paid below-average dividends.
Reversal of Fortunes Between Stocks and Bonds
Arnott takes it a step further. “In a world of deleveraging, both for the financial services arena and for the economy at large, growth is less certain,” he says. “And with the economy eroding sharply, so is inflation. If stocks don’t deliver nominal growth in dividends and earnings, then their yield ‘must’ exceed the Treasury yield, in order to give us any sort of risk premium.”
Related: Corporate and Government Bond Rates Graph – Highest Possible Returns – posts on interest rates – investing strategy
The challenges are difficult. I am not confident the current leadership (if their is leadership globally) is capable of making the difficult decisions. There are not easy answers though their are some pretty basic principles people should agree on (excessive leverage is dangerous, massive positions that endanger entire economies are dangerous…). But how to deal with those issues is not easy.
Related: Leverage, Complex Deals and Mania – Treasury Now (1987) Favors Creation of Huge Banks – Monopolies and Oligopolies do not a Free Market Make – Negligent Watchmen
Financial Markets with Professor Robert Shiller (spring 2008) is a fantastic resource from Open Yale courses: 26 webcast (also available as mp3) lectures on topics including: The Universal Principle of Risk Management, Stocks, Real Estate Finance and Its Vulnerability to Crisis, Stock Index, Oil and Other Futures Markets and Learning from and Responding to Financial Crisis (Guest Lecture by Lawrence Summers).
Robert Shiller created the repeat-sales home price index with Karl Case that is known as the Case-Shiller home price index.
Related: Berkeley and MIT courses online – Open Access Education Materials – Curious Cat Science and Engineering Blog open access posts – Paul Krugman Speaks at Google
The New Paradigm for Financial Markets is George Soros‘ newest book. Here is an interview with him in May of this year, on PBS, Financial World Shifts Gears Amid Economic Tumult, about the ideas in the book and the current crisis.
GEORGE SOROS: I think this is the most serious crisis of our lifetime. It’s not just a housing crisis, but a crisis of the financial system.
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GEORGE SOROS: The regulators have failed to regulate, and they really have to — they left it to the market. That was this market fundamentalist philosophy, that markets will take care of themselves.
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And I contend that there’s been what I call a super bubble that has been growing over the last 25 years at least, which basically consisted of an extension in credit, increasing use of leverage. That was the trend in reality.
And the misconception that credit is that markets can be left to their own devices. Now, in fact, they are given to excesses, and occasionally they create crises, but each time the authorities intervene and bail out the failing institutions, provide fiscal stimulus, monetary stimulus.
So it seems like the market corrects itself, but it’s actually the intervention of the authorities that saves the market.
Related: Soros on the Financial Market Collapse – Jim Rogers on the Financial Market Mess – Leverage, Complex Deals and Mania
With the recent turmoil in the financial market this is a good time to look at Dollar cost averaging. The strategy is one that helps you actually benefit from market volatility simply.
You actually are better off with wild swings in stock prices, when you dollar cost average, than if they just went up .8% every single month (if both ended with stocks at the same price 20 years later). Really the wilder the better (the limit is essentially the limit at which the economy was harmed by the wild swings and people decided they didn’t want to take risk and make investments.
Here are two examples, if you invest $1,000 in a mutual fund and the price goes up every year (for this example the prices I used over 20 years: 10, 11, 12, 13, 14, 15, 16, 17, 18, 19, 20, 22, 24, 26, 28, 30, 33, 36,39) you would end up with $40,800 and you would have invested $20,000. The mutual fund went from $10 a share to $39 over that period (which is a 7% return compounded annually for the share price). If you have the same final value but instead of the price going up every year the price was volatile (for example: 10, 11, 7, 12, 16, 18, 20, 13, 10, 16, 20, 15, 24,29, 36, 27, 24, 34, 39) you end up with more most often (in this example: $45,900).
You could actually end up with less if the price shot up well above the final price very early on and then stayed there and then dropped in the last few years. As you get close to retirement (10 years to start paying close attention) you need to adopt a strategy that is very focused on reducing risk of investment declines for your entire portfolio.
The reason you end up with more money is that when the price is lower you buy more shares. Dollar cost averaging does not guaranty a good return. If the investment does poorly over the entire period you will still suffer. But if the investment does well over the long term the added volatility will add to your return. By buying a consistent amount each year (or month…) you will buy more share when prices are low, you will buy fewer shares when prices are high and the effect will be to add to your total return.
Now if you could time the market and sell all your shares when prices peaked and buy again when prices were low you could have fantastic returns. The problem is essentially no-one has been able to do so over the long term. Trying to time the market fails over and over for huge numbers of investors. Dollar cost averaging is simple and boring but effective as long as you chose a good long term investment vehicle.
Investing to your IRA every year is one great way to take advantage of dollar cost averaging. Adding to your 401(k) retirement plan at work is another (and normally this will automatically dollar cost average for you).
Related: Does a Declining Stock Market Worry You? – Save Some of Each Raise – Starting Retirement Account Allocations for Someone Under 40 – Save an Emergency Fund
Would the Dow Dump General Motors?
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At this point, it’s not clear if the government will be willing to take on the horribly mismanaged automaker. It’s one thing to save a financial firm that continues to make money and another thing to rescue a business that for decades has been unable to control labor and legacy costs or deliver a product that consumers want. GM could be allowed to declare bankruptcy.
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But for some reason nostalgic Americans refuse to let the carmakers take a hit and learn from their mistakes. A bailout seems to be preferred. It worked so well for Chrysler.
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Is it important to the Dow editors to keep an auto presence in the index?
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And since the Dow is meant to be a barometer of the U.S. market, Toyota and Honda can’t be considered. Then again maybe they should leave a bankrupt company in the Dow. It might be the most accurate barometer of the market yet by tracking all the blue chips that have gone bankrupt.
I discussed dropping GM from the Dow Jones Industrial Average in December of 2005: “I agree removing GM makes sense, though I see no reason to wait.”
Related: Dow Jones Industrial Average Changes – Another Great Quarter for Amazon (July 2007) – Stop Picking Stocks – Curious Cat Investing Web Search
FDIC Details Plan To Alter Mortgages
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Agency officials estimated the cost to the government at $22.4 billion.
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The mortgage industry is concerned that any new modification plan will persuade some people to stop making mortgage payments in addition to helping people who already have stopped making payments. The industry argues this will translate into higher interest rates because investors will demand compensation for the increased risk of loan defaults. That, in turn, would limit the number of people who can afford mortgage loans.
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FDIC estimates that 1.4 million borrowers with such loans are at least two months late on their payments, and another 3 million borrowers will miss at least two payments by the end of next year. The agency estimates that half those borrowers, or about 2.2 million people, would receive a loan modification under the program, and that about 1.5 million will successfully avoid foreclosure.
Under the terms of the proposed FDIC program, lenders would reduce monthly payments primarily by cutting the borrower’s interest rate to a minimum rate of 3 percent. If necessary, the company could also extend the repayment period on the loan beyond 30 years, reducing each monthly payment. Finally, in some cases, companies could defer repayment of some principal. The borrower still would be on the hook for the full value of the loan.
Officials said their experience at IndyMac showed that principal reductions were not necessary. So far, FDIC has modified about 20,000 IndyMac loans. In 70 percent of the cases, FDIC was able to create an affordable payment solely by reducing the interest rate. In 21 percent of the cases, the agency also extended the life of the loan. In 9 percent of the cases, it delayed repayment of some principal.
An interesting proposal I would support. Ideally this type of action would not be necessary but since banks were allowed to degrade their standards so far and allowed to grow so large their failures threaten the economy some radical actions are being taken. Compared to many others this is sensible.
Related: How Much Worse Can the Mortgage Crisis Get? – JPMorgan Chase Freezes Mortgage Foreclosures – Fed Plans To Curb Mortgage Excesses (Dec 2007)
It doesn’t take much effort to notice the economic news is increasingly dire. And this is not just a few alarmist reports, the economy is in serious trouble. The decades of spending beyond their means (for consumers and those the consumers elected to run government) are creating a very difficult situation. And the credit crisis precipitating the current slide has brought to light many failures to properly regulate the economy. U.S. Slump May Be Longest in Decades as Growth Fell Off ‘Cliff’
The implosion of credit markets last month will cause the economy to shrink at a 3 percent annual rate in the fourth quarter and decline at a 1.5 percent pace in the first three months of 2009, according to the median estimate of 59 economists surveyed Nov. 3 to Nov. 11. Following last quarter’s 0.3 percent drop, the slump would be the longest since 1974-75.
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Falling demand will cause an even bigger increase in unemployment than projected last month. Economists surveyed forecast the jobless rate will rise to 7 percent in the first quarter of 2009, up from last month’s forecast of 6.6 percent. The rate will climb to 7.7 percent by the end of 2009, the highest level since 1992, the survey showed.
The jobless rate rose to 6.5 percent in October, the highest since 1994
There is little doubt the economy is in for serious trouble. What investment moves are wise now is less obvious. I have been buying during the decline and continue to do so. I bought some Google yesterday at the same price I first bought Google for several years ago. I think in 10 years that will pay off quite well, but time will tell. My purchases of Google earlier this year would obviously have been better if I had made them yesterday than when I did.
I discussed the Economic Crisis on my Curious Cat Management Blog last month:
One of the challenges with personal financial matters is they are by nature long term issues. What you did over the last 5 years cannot be fixed in a few weeks, most likely it takes years.
Related: Stock Market Decline – Bad News on Jobs
Consumer debt gets bailout attention
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“Approximately 40 percent of U.S. consumer credit is provided through securitization of credit card receivables, auto loans and student loans and similar products. This market, which is vital for lending and growth, has for all practical purposes ground to a halt.”
The Next Meltdown: Credit-Card Debt
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Innovest estimates that credit-card issuers will take a $41 billion hit from rotten debt this year and a $96 billion blow in 2009.
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Risky borrowers with low credit scores account for roughly 30% of outstanding credit-card debt, compared with 11% of mortgage debt. More than 45% of Washington Mutual’s credit-card portfolio is subprime, according to Innovest.
Related: Americans are Drowning in Debt – How to Use Your Credit Card – Credit Crisis (Aug 2007) – Curious Cat Economics Search Engine