There are times when investors want to find reasons to see the glass as half-empty—looking for some issue or problem to confirm our fears and justify scaling back our positions or becoming more conservative in our investing. Last week was one of those times. It should have been a good week for stocks, between Bernanke’s reconfirmation, better-than-expected corporate earnings and a +5.7% jump in GDP for the 4th quarter, the most in six years. Instead, we saw sharp declines in stocks around the world from Tuesday through Friday. The two most obvious scapegoats are Greece, with the possibility of its national government defaulting on its debts, and China, which intends to curtail its own economic growth over fears of future inflation.
Analysts and stock market reporters can write much better stories by looking at what happened (stocks fell) and trying to explain why it happened (people were scared about Greece and China) rather than addressing the real issue—investors are still scared of being burned, and are looking for every reason not to invest, even if they are not good reasons.
We haven’t seen a national government default since Argentina in 2002. Before that we saw Russia and Ecuador in 1998 and North Korea in 1987 (that last one must have been a real shocker!). And though there is a slim possibility that Greece could default on its debt, I find it hard to believe, especially in view of recent statements, that the other EU nations will let this happen and endanger their monetary union. It is hard to say what effect an EU bailout of Greece would have on the US stock market, but the distant possibility of a foreign default is not reason enough for investors to shy away from investing when conditions are otherwise as promising as they were last week.
With China, why is it such a big problem if the government there wants to ease growth from too fast to just fast enough? Might they overshoot and slow the economy more than they would like? Of course they could, but their recent actions to rein in lending were triggered by data showing that the Chinese economy has been growing much faster than expected. Even investors in “China-sensitive” stocks, such as energy and materials, must have been surprised by 2009’s upwardly revised GDP figure of +8.2%. China’s economic growth rate had actually been accelerating throughout last year. The rest of the world should be so lucky.
Make no mistake, I am not saying that the possibility of Greece defaulting or China’s future economic growth slowing a little too much should not be considered in our decisions today, because they could affect our global economy and equity markets. I just question the sudden and indiscriminate selling of securities amidst the reality of better than expected economic news and corporate earnings reports on the basis of “what-if” scenarios that probably won’t ever happen.
Tuesday, February 2, 2010
Friday, January 22, 2010
No Healthcare Bill -- What Now?
Healthcare stocks rallied Tuesday morning when it was all but confirmed that Massachusetts Republican Scott Brown would be Ted Kennedy’s replacement in the Senate, likely dooming Obama’s healthcare initiative. Reports from Wall Street indicated a sense of relief among healthcare investors, in large part because we would not have to deal with the uncertainty of a restructured health insurance system. Famed stock trader Jesse Livermore said that “all through time, people have basically acted and reacted the same way in the market as a result of: greed, fear, ignorance, and hope.” Aside from investors’ aversion to change of any kind, the situation surrounding the healthcare bill can be attributed to two of these emotions – fear and ignorance.
How many people can say they understand the intricacies of Obama’s healthcare plan? Not very many – and even for those who do, there are too many factors to take into account to predict its long-term effect on the healthcare industry or the overall economy. Nonetheless, due to the uncertainty of the proposed plan, stocks of managed care companies and pharmaceutical firms performed poorly in 2009 relative to the market. But as it became less probable that we would see a dramatic restructuring of the healthcare system, these firms’ stocks started to rally strongly.
This is a clear example of how fear and ignorance drive investment decisions. We fear the proposed change, and we are too ignorant to embrace the possibility of the change producing a good outcome. Obviously there are political and selfish motivations for opposition to the plan, but for all we know Obamacare could be a good thing for the healthcare industry. (Medicare was fought bitterly in the 1960’s, yet it drove tremendous growth and innovation in healthcare.) For example, millions of uninsured Americans would become policyholders, potentially increasing the revenues of health insurers, along with doctors, hospitals and pharmaceutical companies. Or it could cause a nightmare for healthcare companies and their investors, as many believe. Nobody can know for certain, but one thing we do know is that we’re scared to death to find out.
In any case, the battle over Obamacare has certainly confirmed Jesse Livermore’s assertion – at least the part about fear and ignorance.
How many people can say they understand the intricacies of Obama’s healthcare plan? Not very many – and even for those who do, there are too many factors to take into account to predict its long-term effect on the healthcare industry or the overall economy. Nonetheless, due to the uncertainty of the proposed plan, stocks of managed care companies and pharmaceutical firms performed poorly in 2009 relative to the market. But as it became less probable that we would see a dramatic restructuring of the healthcare system, these firms’ stocks started to rally strongly.
This is a clear example of how fear and ignorance drive investment decisions. We fear the proposed change, and we are too ignorant to embrace the possibility of the change producing a good outcome. Obviously there are political and selfish motivations for opposition to the plan, but for all we know Obamacare could be a good thing for the healthcare industry. (Medicare was fought bitterly in the 1960’s, yet it drove tremendous growth and innovation in healthcare.) For example, millions of uninsured Americans would become policyholders, potentially increasing the revenues of health insurers, along with doctors, hospitals and pharmaceutical companies. Or it could cause a nightmare for healthcare companies and their investors, as many believe. Nobody can know for certain, but one thing we do know is that we’re scared to death to find out.
In any case, the battle over Obamacare has certainly confirmed Jesse Livermore’s assertion – at least the part about fear and ignorance.
Friday, January 15, 2010
Roth Conversion—Much Ado about Anything?
This year, everyone seems so excited about the new guidelines for converting your traditional IRA to a Roth IRA. For those of you living in a cave, the new rule that took effect at the beginning of the year allows anyone to convert a traditional IRA to a Roth. Before 2010, you could only convert if your modified adjusted gross income was less than $100,000/year. Also, a “one-time special offer” allows the tax burden from the conversion to be spread over the next two years. While the new guidelines provide a potentially money-saving opportunity for some people, it’s far from the “no-brainer” that many financial columnists would lead you to believe.
A traditional IRA is typically funded by pre-tax dollars, providing a tax write-off when you make the contribution, but the withdrawals are taxed as ordinary income. They also require investors to begin withdrawing money at age 70 ½ in the form of required minimum distributions (RMD). To make matters worse, your withdrawals could push you into a higher tax bracket and force you to pay more taxes than necessary. On the other hand, a Roth IRA taxes the funds contributed at the time of contribution, with the promise of tax-free withdrawals in the future and no distribution requirements. It sounds like a slam dunk to convert, but everyone’s situation is different, making the answer to the question fuzzy and in need of case-by-case analysis.
Lifting the income restrictions for Roth conversions, and incentivizing the move even more with drawn out taxation, certainly makes sense for the government. During the next two years, the Federal and state governments will realize tax dollars they would not have seen for years from people who take advantage of the new laws. If enough previously excluded investors decide to make the move, it could mean a big near-term payoff for government, especially since far more money is tied up in traditional IRAs than in Roths ($3.7 trillion vs. $178 billion in 2006).
For the individual investor who can comfortably afford the immediate tax burden of conversion, and who is confident that those tax dollars are unlikely to serve a better, more efficient purpose, making the conversion seems like the logical move. But consider the uncertainty of the world we live in, and the nature of financial markets. Also consider a scenario a decade or two down the road where the government, in a similar situation to today, needs to generate revenue. They might not find it hard to justify taking money from rich people who are withdrawing massive amounts of tax-free money from their retirement accounts. Although an unlikely scenario, it forces you to look at the big picture and ask, “Why pay tax now if I can delay it?” Perhaps, 401(k) expert David Loeper said it best in a recent article: “With a highly uncertain future, basic option theory and common sense dictates that we should not pay additional tax now with certainty if we can avoid it, unless there is a clearly compelling advantage to doing so.” Don’t just go blindly and convert; do a thorough analysis and convince yourself that it really makes sense.
For most people, the analysis is too tedious and convoluted to spend time on, and most of the online tools are far too simplistic. If you have a financial advisor that you trust, he or she should do the analysis for you. If you are seriously considering conversion but don’t have a trusted financial advisor, it may be worth the cost to hire one just for this purpose. The fee may justify the wisdom of conversion, or it may save you from paying a lot of income tax today unnecessarily.
A traditional IRA is typically funded by pre-tax dollars, providing a tax write-off when you make the contribution, but the withdrawals are taxed as ordinary income. They also require investors to begin withdrawing money at age 70 ½ in the form of required minimum distributions (RMD). To make matters worse, your withdrawals could push you into a higher tax bracket and force you to pay more taxes than necessary. On the other hand, a Roth IRA taxes the funds contributed at the time of contribution, with the promise of tax-free withdrawals in the future and no distribution requirements. It sounds like a slam dunk to convert, but everyone’s situation is different, making the answer to the question fuzzy and in need of case-by-case analysis.
Lifting the income restrictions for Roth conversions, and incentivizing the move even more with drawn out taxation, certainly makes sense for the government. During the next two years, the Federal and state governments will realize tax dollars they would not have seen for years from people who take advantage of the new laws. If enough previously excluded investors decide to make the move, it could mean a big near-term payoff for government, especially since far more money is tied up in traditional IRAs than in Roths ($3.7 trillion vs. $178 billion in 2006).
For the individual investor who can comfortably afford the immediate tax burden of conversion, and who is confident that those tax dollars are unlikely to serve a better, more efficient purpose, making the conversion seems like the logical move. But consider the uncertainty of the world we live in, and the nature of financial markets. Also consider a scenario a decade or two down the road where the government, in a similar situation to today, needs to generate revenue. They might not find it hard to justify taking money from rich people who are withdrawing massive amounts of tax-free money from their retirement accounts. Although an unlikely scenario, it forces you to look at the big picture and ask, “Why pay tax now if I can delay it?” Perhaps, 401(k) expert David Loeper said it best in a recent article: “With a highly uncertain future, basic option theory and common sense dictates that we should not pay additional tax now with certainty if we can avoid it, unless there is a clearly compelling advantage to doing so.” Don’t just go blindly and convert; do a thorough analysis and convince yourself that it really makes sense.
For most people, the analysis is too tedious and convoluted to spend time on, and most of the online tools are far too simplistic. If you have a financial advisor that you trust, he or she should do the analysis for you. If you are seriously considering conversion but don’t have a trusted financial advisor, it may be worth the cost to hire one just for this purpose. The fee may justify the wisdom of conversion, or it may save you from paying a lot of income tax today unnecessarily.
Friday, November 20, 2009
The Chips Fall Down
Today was the first real down day we’ve had in a couple of weeks. There was no specific reason for it, which is usually a good sign. After several big up days (the S&P 500 had jumped over +6% in just 11 trading days), it was time for a little selling (the pros call it “profit taking”). The financial press blamed it on a Bank of America analyst who downgraded 10 computer chip companies, including Intel, because of a potential “inventory overshoot” next year. But European markets were falling before this analyst opened his mouth, so investors were already in a selling mood prior to the opening bell in New York.
What about this feared “inventory overshoot?” Well, chip companies, along with just about everyone else, have pared their inventories to the bone during the recession. Now they’re finally starting to restock in anticipation of future demand. The concern is that they’ll overshoot, and have too much inventory by sometime next year. This would cause them to reduce production in order to work off the excess inventory. Could this happen? Of course; no one can predict demand precisely enough to always have the right amount of inventory. Will it matter? Probably not. Temporary mismatches between inventory and sales are common in business. Besides, the semiconductor industry is anticipated to grow 18% in 2010; I expect it could be more than this.
I bring up this rather arcane story because of something that happened to me recently, and which reminded me how low inventories have become. I ordered some additional memory for my Power Mac at home: 2 GB DIMMs, direct from the manufacturer (Micron Technology). That was several days ago, and the order hasn’t yet shipped. Why? The manufacturer is out of stock! We’re in the deepest recession since WWII and Micron can’t keep up with demand for its memory chips. So we already have at least one mismatch between sales and inventory: too little inventory. With demand increasing, manufacturers are going to have to ramp up big time to replenish their meager stocks. Also, I wouldn’t be surprised to see a lot of the more popular items sell out over the holidays. (You might want to finish your holiday gift shopping early this year.)
Most economic data and corporate earnings continue to exceed expectations. Earlier this week, Japan’s GDP report showed annualized growth of +4.8% in the 3rd quarter, more than twice what was forecast. And just a few minutes ago, the Bank of Japan upgraded its view of the country’s economic outlook, while leaving interest rates at historical lows. The global economy is clearly on the mend, but hardly anyone seems to notice, focusing as they do on lagging indicators like employment.
Except the stock market, that is. Global equities (as measured by the MSCI ACWI) are up over +70% since their March low. That’s a very impressive move in less than 9 months. Yet there are more than a few who think this huge up move is a head fake—a “countertrend” rally in a longer-term bear market. They think that we’re in the 1970’s all over again. Back then, stocks made little headway for the 16 years from 1966 to 1982. If they’re right, so the story goes, that could mean little upward progress until 2016. Not a pleasant thought.
But even if we’re “back to the ‘70s,” the stock market’s future could still be quite bright. Because what you don’t hear about those 16 years of stagflation is that the low point occurred in 1974, just under 9 years after the prior peak. Between December 1974 and the August 1982 “bottom,” which marked the beginning of an 18-year bull market, the S&P 500 had a total return of about +125%. Not bad for a bear market!
Coincidentally, the March 2009 low of this bear is exactly 9 years from the March 2000 peak. So even if 2009 is like 1974, there could still be a lot of appreciation before the next “official” bull market begins, as stocks have so far only risen about half as much from their lows as they did from 1974 to 1982. So even the worst-case scenario doesn’t sound so bad.
Also, if this is a “counter-trend” rally, it would be the longest and most powerful in history. The previous record is held by the initial rally after the crash of 1929, when the Dow Jones Industrial Average (there was no S&P 500 back then) rose +48% in 4 months before beginning its dizzying 3-year drop. The current rally is already significantly stronger and more than twice as long. The chances that the bear market of 2007–2009 is not yet over are, in my view, incredibly small. (And if this really is the first rally of a new bull market, as I believe, there’s a LOT more upside ahead.)
Too bad for the average investor, as mutual fund data indicate that a great many have been sitting out this rally, waiting (perhaps hoping is a better word) for a big decline that will allow them to get back in at much better prices. They are likely to have a very long wait. I said it in March and I’ll say it now: I don’t think we will ever again see the S&P 500 at 666 or the Dow at 6,500. Not just in our lifetimes. Ever. So stop waiting for the other shoe to drop. Yes, there are lots of problems, and yes, there will be more economic crises and bear markets in future years. But there will be no more falling footwear in 2010.
What about this feared “inventory overshoot?” Well, chip companies, along with just about everyone else, have pared their inventories to the bone during the recession. Now they’re finally starting to restock in anticipation of future demand. The concern is that they’ll overshoot, and have too much inventory by sometime next year. This would cause them to reduce production in order to work off the excess inventory. Could this happen? Of course; no one can predict demand precisely enough to always have the right amount of inventory. Will it matter? Probably not. Temporary mismatches between inventory and sales are common in business. Besides, the semiconductor industry is anticipated to grow 18% in 2010; I expect it could be more than this.
I bring up this rather arcane story because of something that happened to me recently, and which reminded me how low inventories have become. I ordered some additional memory for my Power Mac at home: 2 GB DIMMs, direct from the manufacturer (Micron Technology). That was several days ago, and the order hasn’t yet shipped. Why? The manufacturer is out of stock! We’re in the deepest recession since WWII and Micron can’t keep up with demand for its memory chips. So we already have at least one mismatch between sales and inventory: too little inventory. With demand increasing, manufacturers are going to have to ramp up big time to replenish their meager stocks. Also, I wouldn’t be surprised to see a lot of the more popular items sell out over the holidays. (You might want to finish your holiday gift shopping early this year.)
Most economic data and corporate earnings continue to exceed expectations. Earlier this week, Japan’s GDP report showed annualized growth of +4.8% in the 3rd quarter, more than twice what was forecast. And just a few minutes ago, the Bank of Japan upgraded its view of the country’s economic outlook, while leaving interest rates at historical lows. The global economy is clearly on the mend, but hardly anyone seems to notice, focusing as they do on lagging indicators like employment.
Except the stock market, that is. Global equities (as measured by the MSCI ACWI) are up over +70% since their March low. That’s a very impressive move in less than 9 months. Yet there are more than a few who think this huge up move is a head fake—a “countertrend” rally in a longer-term bear market. They think that we’re in the 1970’s all over again. Back then, stocks made little headway for the 16 years from 1966 to 1982. If they’re right, so the story goes, that could mean little upward progress until 2016. Not a pleasant thought.
But even if we’re “back to the ‘70s,” the stock market’s future could still be quite bright. Because what you don’t hear about those 16 years of stagflation is that the low point occurred in 1974, just under 9 years after the prior peak. Between December 1974 and the August 1982 “bottom,” which marked the beginning of an 18-year bull market, the S&P 500 had a total return of about +125%. Not bad for a bear market!
Coincidentally, the March 2009 low of this bear is exactly 9 years from the March 2000 peak. So even if 2009 is like 1974, there could still be a lot of appreciation before the next “official” bull market begins, as stocks have so far only risen about half as much from their lows as they did from 1974 to 1982. So even the worst-case scenario doesn’t sound so bad.
Also, if this is a “counter-trend” rally, it would be the longest and most powerful in history. The previous record is held by the initial rally after the crash of 1929, when the Dow Jones Industrial Average (there was no S&P 500 back then) rose +48% in 4 months before beginning its dizzying 3-year drop. The current rally is already significantly stronger and more than twice as long. The chances that the bear market of 2007–2009 is not yet over are, in my view, incredibly small. (And if this really is the first rally of a new bull market, as I believe, there’s a LOT more upside ahead.)
Too bad for the average investor, as mutual fund data indicate that a great many have been sitting out this rally, waiting (perhaps hoping is a better word) for a big decline that will allow them to get back in at much better prices. They are likely to have a very long wait. I said it in March and I’ll say it now: I don’t think we will ever again see the S&P 500 at 666 or the Dow at 6,500. Not just in our lifetimes. Ever. So stop waiting for the other shoe to drop. Yes, there are lots of problems, and yes, there will be more economic crises and bear markets in future years. But there will be no more falling footwear in 2010.
Monday, November 2, 2009
Day of the Dead?
I wasn’t planning to write 3 daily emails in a row, but after today’s stock market reversal, I thought it would be a good idea going into the weekend.
As you probably know, stocks took back yesterday’s gains and a bit more today. So in 3 days, we’ve had 3 big moves: down—up—down. So should Monday be up? Who knows; investors have all weekend to stew about it.
Yesterday, it seemed pretty clear that the rally was driven by the better-than-expected GDP report. So what drove today’s drop? Whatever it was, I don’t think it was news. The only significant report to come out today was consumer spending, which was down –0.5% for September after several months in a row of increases. But this was exactly the number that economists expected, and was largely the result of a decline in car purchases after the expiration of the “cash for clunkers” program (see yesterday’s email for a discussion of this). Outside of motor vehicles, most areas of consumer spending actually increased.
Today was the last trading day of the month, and the last day of the fiscal year for many mutual funds. So “portfolio window dressing” could have had an impact on today’s trading. Also, volatility has been increasing rapidly over the past few days, which often scares people out of stocks. Volatility tends to peak at inflection points in the market, particularly at bottoms. Currently, we’re at about the same level of volatility as we were at the market’s July low, which was the end of a –7% correction; as of today, the S&P 500 is down about –6% from it’s October peak.
It thus seems that we’re in the process of forming a base from which another significant rally can start. Whether it begins as soon as next week or later is impossible to guess, but I doubt it will take more than a few weeks for the market—and investor sentiment—to turn around again. Interestingly, investor sentiment is also at about the same level as it was at the July bottom, yet the S&P 500 is nearly +18% higher than it was then. The wall of worry that typically drives bull markets remains solid.
Yes, this has been a disappointing week, and scary, too, owing to big daily price swings. But the S&P 500 is down barely –2% for the month, which is only 1/10th of its drop of last October. And this came after 7 consecutive months of gains. A pause in the upward momentum shouldn’t be a surprise. I think this pause will be one that refreshes, similar to the one in July. You may not remember, but back then the stock market made no headway at all for 2 full months, and was actually –5.4% lower in early July than it had been in early May. But those who stayed put and didn’t panic have already been rewarded with a double-digit gain.
As you probably know, stocks took back yesterday’s gains and a bit more today. So in 3 days, we’ve had 3 big moves: down—up—down. So should Monday be up? Who knows; investors have all weekend to stew about it.
Yesterday, it seemed pretty clear that the rally was driven by the better-than-expected GDP report. So what drove today’s drop? Whatever it was, I don’t think it was news. The only significant report to come out today was consumer spending, which was down –0.5% for September after several months in a row of increases. But this was exactly the number that economists expected, and was largely the result of a decline in car purchases after the expiration of the “cash for clunkers” program (see yesterday’s email for a discussion of this). Outside of motor vehicles, most areas of consumer spending actually increased.
Today was the last trading day of the month, and the last day of the fiscal year for many mutual funds. So “portfolio window dressing” could have had an impact on today’s trading. Also, volatility has been increasing rapidly over the past few days, which often scares people out of stocks. Volatility tends to peak at inflection points in the market, particularly at bottoms. Currently, we’re at about the same level of volatility as we were at the market’s July low, which was the end of a –7% correction; as of today, the S&P 500 is down about –6% from it’s October peak.
It thus seems that we’re in the process of forming a base from which another significant rally can start. Whether it begins as soon as next week or later is impossible to guess, but I doubt it will take more than a few weeks for the market—and investor sentiment—to turn around again. Interestingly, investor sentiment is also at about the same level as it was at the July bottom, yet the S&P 500 is nearly +18% higher than it was then. The wall of worry that typically drives bull markets remains solid.
Yes, this has been a disappointing week, and scary, too, owing to big daily price swings. But the S&P 500 is down barely –2% for the month, which is only 1/10th of its drop of last October. And this came after 7 consecutive months of gains. A pause in the upward momentum shouldn’t be a surprise. I think this pause will be one that refreshes, similar to the one in July. You may not remember, but back then the stock market made no headway at all for 2 full months, and was actually –5.4% lower in early July than it had been in early May. But those who stayed put and didn’t panic have already been rewarded with a double-digit gain.
Friday, October 30, 2009
From frightened to fearless
What a difference a day makes!
Yesterday I opined that a better-than-expected GDP reading today could turn the market around and send stocks up again. That’s just what happened: 3rd-quarter GDP came out at +3.5%, better than the +3.3% “consensus” estimate. Stocks shot up right out of the gate and did not look back. By the time the closing bell sounded, the Dow was up 200 points (+2.1%) and the S&P 500 had jumped 23.5 points (+2.3%). Today also represents the biggest one-day rise since July 23.
So is the correction over already? It could be, as the length and depth of the drop has been similar to the several we have seen since March. Also, we are entering a seasonally strong period (November through May), which typically sees the best gains of the year. On the other hand, the market is much pricier now than it was just a few months ago, meaning that the bar is moving higher for good news to have a positive impact. Though I personally believe that we will see more positive surprises than negative ones over the next few quarters, that doesn’t mean we won’t have periodic setbacks.
You may have heard in the news that a lot of the growth in GDP last quarter came from government programs, such as “cash for clunkers” and the home buyers’ credit. One article said that “stripping out auto output, the economy would have expanded at only a 1.9 percent rate in the third quarter.” There are at least two problems with these statements. One is that it doesn’t matter why people buy something: a purchase is a purchase. Government incentives may be driving some sales now, but once they fade, other reasons could take over. The argument that consumption will suddenly stagnate without government incentives is specious.
The second problem with these statements is that they are just plain wrong. My own calculations from actual government data show that if one stripped out all auto sales directly attributable to the cash for clunkers program (670,557 vehicles at an average price of $28,400 = $19 billion), the economy still would have expanded by $93.5 billion last quarter, or 3.0% annualized. This is still a respectable advance, and well above the 1.9% claimed above. (You could calculate a growth of just over 2% if you stripped out all durable goods sales, including not just cars and trucks, but washing machines, furniture, heavy equipment, iPhones, etc.) On top of this, a large percentage of people who bought cars under the government’s program said they would have done so anyway.
What about the homebuyer’s credit? This is harder to calculate, because only new home construction and real estate commissions affect GDP; sales of existing homes or new homes sitting vacant since the prior quarter are not counted. It’s difficult to discern whether the home buyer credit caused an increase in the construction of new homes, and by how much, but I’m going to try. A study by Goldman-Sachs estimates that the tax credit has enticed about 200,000 more homebuyers to enter the market. About 1.5 million homes sold in the 3rd quarter. Let’s assume that all 200,000 of those first-time homebuyers bought a home last quarter; this would mean that 13% of sales were from these government-incentivized buyers. Let’s further assume that home construction increased proportionately.
According to the government GDP release, new home construction added 0.53% to GDP last quarter. (This is, by the way, the first time that residential construction was a positive contributor to the economy, rather than a drag, since 4th quarter 2005, when it added a whopping 0.1%!) If 13% of that was caused by the home buyer credit, then this government program added all of 0.07% to GDP. So without the credit, GDP growth last quarter would “only” have been +3.43%.
Take out both programs, and GDP would still have risen by about +2.9%, considerably better than economists were estimating just a month ago. What about direct government expenditures, or the rest of the stimulus program? Non-defense federal expenditures and investment added all of 0.17% to GDP last quarter, about the same as 2nd quarter; this is actually less than it contributed during several quarters in 2003 to 2006, when the economy was doing well. So direct government expenditures are not driving our economy, either. (As a comparison, during WWII military expenditures added a whopping 29% to GDP in 1942 and 19.5% in 1943; today they add between 0 and 0.4%.)
So those who say that government stimulus is primarily supporting our economy are misreading the data. Interestingly, these are often the same people who say that government stimulus programs don’t work. Now I’m not going to get into the economics nor the politics of this hot potato. I’m just going to conclude that the recession is over, the economy has started growing again—with or without government help—and good times will eventually follow.
Yesterday I opined that a better-than-expected GDP reading today could turn the market around and send stocks up again. That’s just what happened: 3rd-quarter GDP came out at +3.5%, better than the +3.3% “consensus” estimate. Stocks shot up right out of the gate and did not look back. By the time the closing bell sounded, the Dow was up 200 points (+2.1%) and the S&P 500 had jumped 23.5 points (+2.3%). Today also represents the biggest one-day rise since July 23.
So is the correction over already? It could be, as the length and depth of the drop has been similar to the several we have seen since March. Also, we are entering a seasonally strong period (November through May), which typically sees the best gains of the year. On the other hand, the market is much pricier now than it was just a few months ago, meaning that the bar is moving higher for good news to have a positive impact. Though I personally believe that we will see more positive surprises than negative ones over the next few quarters, that doesn’t mean we won’t have periodic setbacks.
You may have heard in the news that a lot of the growth in GDP last quarter came from government programs, such as “cash for clunkers” and the home buyers’ credit. One article said that “stripping out auto output, the economy would have expanded at only a 1.9 percent rate in the third quarter.” There are at least two problems with these statements. One is that it doesn’t matter why people buy something: a purchase is a purchase. Government incentives may be driving some sales now, but once they fade, other reasons could take over. The argument that consumption will suddenly stagnate without government incentives is specious.
The second problem with these statements is that they are just plain wrong. My own calculations from actual government data show that if one stripped out all auto sales directly attributable to the cash for clunkers program (670,557 vehicles at an average price of $28,400 = $19 billion), the economy still would have expanded by $93.5 billion last quarter, or 3.0% annualized. This is still a respectable advance, and well above the 1.9% claimed above. (You could calculate a growth of just over 2% if you stripped out all durable goods sales, including not just cars and trucks, but washing machines, furniture, heavy equipment, iPhones, etc.) On top of this, a large percentage of people who bought cars under the government’s program said they would have done so anyway.
What about the homebuyer’s credit? This is harder to calculate, because only new home construction and real estate commissions affect GDP; sales of existing homes or new homes sitting vacant since the prior quarter are not counted. It’s difficult to discern whether the home buyer credit caused an increase in the construction of new homes, and by how much, but I’m going to try. A study by Goldman-Sachs estimates that the tax credit has enticed about 200,000 more homebuyers to enter the market. About 1.5 million homes sold in the 3rd quarter. Let’s assume that all 200,000 of those first-time homebuyers bought a home last quarter; this would mean that 13% of sales were from these government-incentivized buyers. Let’s further assume that home construction increased proportionately.
According to the government GDP release, new home construction added 0.53% to GDP last quarter. (This is, by the way, the first time that residential construction was a positive contributor to the economy, rather than a drag, since 4th quarter 2005, when it added a whopping 0.1%!) If 13% of that was caused by the home buyer credit, then this government program added all of 0.07% to GDP. So without the credit, GDP growth last quarter would “only” have been +3.43%.
Take out both programs, and GDP would still have risen by about +2.9%, considerably better than economists were estimating just a month ago. What about direct government expenditures, or the rest of the stimulus program? Non-defense federal expenditures and investment added all of 0.17% to GDP last quarter, about the same as 2nd quarter; this is actually less than it contributed during several quarters in 2003 to 2006, when the economy was doing well. So direct government expenditures are not driving our economy, either. (As a comparison, during WWII military expenditures added a whopping 29% to GDP in 1942 and 19.5% in 1943; today they add between 0 and 0.4%.)
So those who say that government stimulus is primarily supporting our economy are misreading the data. Interestingly, these are often the same people who say that government stimulus programs don’t work. Now I’m not going to get into the economics nor the politics of this hot potato. I’m just going to conclude that the recession is over, the economy has started growing again—with or without government help—and good times will eventually follow.
Wednesday, October 28, 2009
Why is Wall Street spooked?
Judging by the talking heads in the news media, you’d think the nascent recovery has come to a grinding halt. Despite over 80% of S&P 500 companies beating their earnings estimates, with many also showing higher sales than expected, gloom is everywhere. Consumer confidence has fallen for 2 months in a row. Forecasters are starting to ratchet down their 3rd-quarter GDP growth estimates. And the equity markets have taken back their October gains, putting us about flat for the month. This many be disappointing, but after last October, when global markets plunged –20%, a merely flat month should be something to cheer about. After all, even in a roaring bull market, stocks never go up every month. But why is this happening in the context of mostly positive news?
The obvious answer is that stock prices already incorporate the good news, while the few pieces of unexpected bad news (an earnings miss here, a surprise drop in new home sales there) are drawing everyone’s attention. During periods of economic growth, there are times when growth stalls or even backtracks. This has been the case in every recovery. Stocks tend to follow a similar pattern, with an overall uptrend punctuated by periodic setbacks. A drop in stock prices tends to reinforce the pessimism that triggered the drop in the first place. Eventually, pessimism peaks and the markets hit a near-term bottom. At this point, the uptrend can start again.
There’s clearly no way to know exactly when this will occur. If I did, I’d buy only on the days when each downtrend reversed and do all my selling just before each drop started. So although I claim no special clairvoyance (never have, never will), I sense that we’re close to a reversal back toward the upside, which could start as early as Thursday or Friday. A lot will depend on how the “flash” GDP number looks tomorrow. It it’s much better than expected, stocks could soar; if worse, they could fall some more before turning up again.
This GDP number is particularly important because it will likely represent the first quarter of economic growth in well over a year. Investors and economists are anxiously awaiting the “official” number, even though this initial estimate will be revised 2 or 3 times over the next several months, and “flash” reports are notoriously inaccurate. Even so, people will parse the details behind the aggregate number looking for clues to the future trajectory of economic growth in the US (despite the well-known fact that predicting the future by examining the past is futile).
On top of anxiety of tomorrow’s GDP report, and ongoing fears regarding bank solvency and the commercial real estate market (universally described as “the next shoe to drop”), we’ve had a couple of well-regarded investors call a near-term top to the current bull market. These include Bill Gross, chairman of PIMCO and one of the best bond managers in the word, and Jeremy Grantham, a well-known equity investor who supposedly predicted the 2008 downturn. Not surprisingly, many people take these pronouncements seriously, even though the smartest person is as likely to be wrong as right when predicting the future. And by the way, Bill Gross, despite his expertise in bonds, has a terrible track record in predicting the stock market (good thing he sticks to bonds when investing). And Jeremy Grantham not only predicted a bear market in 2008, but also in 2003, 2004, 2005, 2006 and 2007. (Nothing like being 5 years too early!) And by the way, despite being an avowed bear, Grantham still has 62% of his clients’ funds in equities. Go figure.
In sum, nothing that has happened recently has convinced me to change my intermediate- and long-term view that the economy, and along with it, risky assets such as stocks, bonds and commodities, will continue their general uptrend for quite a while. Until pervasive fear is eventually replaced by pervasive greed (something we are not likely to see for several years), every brief downturn and setback will scare the daylights out of most investors. But this sudden increase in the underlying level of fear only serves to form a base for the next leg upward, which these frightened investors will likely miss.
One last note: Americans continue to focus on their own country to the relative exclusion of the rest of the world. This is even more of a mistake today than it was in years past. The US stock market now represents only 42% of world market capitalization, and our GDP is just 25% of world production. And much of the world is growing far faster than the US. South Korea, for example, just reported a surprise 2.9% increase in GDP last quarter (equivalent to 15.4% annual growth). US economists would be giddy if we could produce an annual growth rate of just 6% in a single quarter. Thus, much of the opportunity in investing lies outside the US. This is why over 55% of our clients’ equity investments, and more than 20% of their bonds, are in non-US countries. Why not take advantage of the relative rise of the rest of the world?
Halloween should spook you; Wall Street should not.
The obvious answer is that stock prices already incorporate the good news, while the few pieces of unexpected bad news (an earnings miss here, a surprise drop in new home sales there) are drawing everyone’s attention. During periods of economic growth, there are times when growth stalls or even backtracks. This has been the case in every recovery. Stocks tend to follow a similar pattern, with an overall uptrend punctuated by periodic setbacks. A drop in stock prices tends to reinforce the pessimism that triggered the drop in the first place. Eventually, pessimism peaks and the markets hit a near-term bottom. At this point, the uptrend can start again.
There’s clearly no way to know exactly when this will occur. If I did, I’d buy only on the days when each downtrend reversed and do all my selling just before each drop started. So although I claim no special clairvoyance (never have, never will), I sense that we’re close to a reversal back toward the upside, which could start as early as Thursday or Friday. A lot will depend on how the “flash” GDP number looks tomorrow. It it’s much better than expected, stocks could soar; if worse, they could fall some more before turning up again.
This GDP number is particularly important because it will likely represent the first quarter of economic growth in well over a year. Investors and economists are anxiously awaiting the “official” number, even though this initial estimate will be revised 2 or 3 times over the next several months, and “flash” reports are notoriously inaccurate. Even so, people will parse the details behind the aggregate number looking for clues to the future trajectory of economic growth in the US (despite the well-known fact that predicting the future by examining the past is futile).
On top of anxiety of tomorrow’s GDP report, and ongoing fears regarding bank solvency and the commercial real estate market (universally described as “the next shoe to drop”), we’ve had a couple of well-regarded investors call a near-term top to the current bull market. These include Bill Gross, chairman of PIMCO and one of the best bond managers in the word, and Jeremy Grantham, a well-known equity investor who supposedly predicted the 2008 downturn. Not surprisingly, many people take these pronouncements seriously, even though the smartest person is as likely to be wrong as right when predicting the future. And by the way, Bill Gross, despite his expertise in bonds, has a terrible track record in predicting the stock market (good thing he sticks to bonds when investing). And Jeremy Grantham not only predicted a bear market in 2008, but also in 2003, 2004, 2005, 2006 and 2007. (Nothing like being 5 years too early!) And by the way, despite being an avowed bear, Grantham still has 62% of his clients’ funds in equities. Go figure.
In sum, nothing that has happened recently has convinced me to change my intermediate- and long-term view that the economy, and along with it, risky assets such as stocks, bonds and commodities, will continue their general uptrend for quite a while. Until pervasive fear is eventually replaced by pervasive greed (something we are not likely to see for several years), every brief downturn and setback will scare the daylights out of most investors. But this sudden increase in the underlying level of fear only serves to form a base for the next leg upward, which these frightened investors will likely miss.
One last note: Americans continue to focus on their own country to the relative exclusion of the rest of the world. This is even more of a mistake today than it was in years past. The US stock market now represents only 42% of world market capitalization, and our GDP is just 25% of world production. And much of the world is growing far faster than the US. South Korea, for example, just reported a surprise 2.9% increase in GDP last quarter (equivalent to 15.4% annual growth). US economists would be giddy if we could produce an annual growth rate of just 6% in a single quarter. Thus, much of the opportunity in investing lies outside the US. This is why over 55% of our clients’ equity investments, and more than 20% of their bonds, are in non-US countries. Why not take advantage of the relative rise of the rest of the world?
Halloween should spook you; Wall Street should not.
Tuesday, October 6, 2009
Third quarter, 2009: Best in 11 years
Stocks keep going up, with only minor setbacks, despite all the well-advertised problems with the global economy. The quarter just ended was the best one for the Dow Jones Industrial Average since 4th quarter 1998, and the best third quarter since 1939. For those who like numbers, the MSCI ACWI rose +17.9% during the 3 months ended September 30. The best performers were those very stocks that fell the most in 2008: financials, materials and consumer discretionary companies. This is typical of the early stages of a bull market: those stocks that are hit hardest rebound the fastest.
Why are stocks doing so well? For that matter, why are bonds on a tear as well? We all know that the economy is on the skids, the financial system is still shaky, the real estate market is moribund and unemployment is nearing post-Depression highs. Banks are failing on a weekly basis owing to continuing loan defaults, particularly residential mortgages. Everyone knows that commercial real estate loans are next. US consumers remain stretched, and instead of borrowing more against their homes, are paying down debt and cutting back, both voluntarily and in response to tight credit. Massive layoffs, and fears of being laid off, are naturally exacerbating consumer cutbacks.
Yet through it all, stock prices continue skyward. Even the pullbacks have been relatively short and mild. The deepest drop since the March bottom was about –8%; the current one has only been about –4% so far. This, again, is typical of early bull markets: the first real correction of –10% or greater doesn’t usually occur for 12 to 18 months or more. By now you know that the stock market doesn’t react to the economy; rather, it anticipates it. Thus, the sharp rise in equity prices over the past 7 months points to an improving economy, and recent data confirm this view. So a rising market at this point should be no surprise.
Many people, however, worry that stocks have come too far, too fast. After all, a +69% jump in just a few months seems overdone. Surely, we must be due for a substantial drop, even if the economy continues to recover. And if we have a “double dip” recession, then a drop must certainly be in the cards.
The problem with this logic is that all of these risks are well known. Stock prices don’t react to known information, but only to surprises. And by definition, a surprise cannot be anticipated. Thus, the only thing that should cause a major change in the direction of the market is something bad that happens out of the blue. A major war with Iran could be in this category, although even that risk is starting to be discounted by the market. Continuing loan defaults and home foreclosures, lousy corporate earnings, sluggish consumer spending and rising unemployment are widely known problems that no longer have market-moving power.
Moreover, most of the surprises over the past several months have been of the positive variety. Corporate earnings are mostly better than predicted. GDP growth worldwide is coming in higher than expected. And the status of the banking industry is no longer dire. In fact, the European Union recently completed a “stress test” of its 22 largest banks (accounting for 60% of deposits in the EU) and found that they are in surprisingly good shape. None are likely to need additional capital even if the economy does much worse than expected (and yet, many are raising additional capital anyway, and successfully at that).
The other thing to keep in mind when looking at stock prices is that using the March 9 low as an anchor can be very misleading. Yes, stocks are up hugely since then, but the global bear market that took them to those lows was more severe than any since 1721 (and worse in the US than any since 1932). At the levels of this March, stock prices were pricing in a total meltdown of the financial system that never occurred. At their present levels, they are predicting a gradual recovery from a severe recession, yet remain –31% below their highs of 2007. Just to get back to those levels, the MSCI ACWI needs to rise +45% from here. This return trip will probably take another 3 years, which means the economy won’t be back to early 2008 levels until 2013. This may seem painfully slow, but it represents an annual return of over +15% including dividends—far more than you’re likely to receive from most other investments.
Over the past week or so, people have been focusing on the lousy employment numbers and what the very slow recovery of the job market might mean to the economy. The reasoning goes that we can’t see meaningful GDP growth while unemployment continues to rise and the consumer holds back. But history shows the fallacy of this reasoning: employment is one of the last indicators to turn positive, well after GDP has started growing again and the stock market recovered. During the past 4 recessions, employment didn’t start growing again until an average of 8 months after the stock market bottomed.
But job recovery keeps taking longer, for a variety of reasons. After the 1990 recession induced by the S&L crisis, for example, unemployment didn’t peak until 16 months after the market started to rebound, by which time it was already up +40% (and this after a relatively mild –20% bear market). Job recovery this time will likely take at least that long, meaning that we’re not likely to see a peak in unemployment until next July. And by then, stocks could well be significantly higher than today.
So while the gains in all asset classes have been impressive over the past several months, most investors missed it. They opted for “safe” investments such as CD’s, US Treasuries and money market funds, happy to earn 1% or even less. On top of this, most investors that were willing to take some risk did so with bonds rather than stocks: from March through mid-September, mutual fund investors put 20 times as much into bond funds as stock funds. (In contrast, during the preceding bull market, stock mutual funds received 2.5 times more money than bond funds.) One has to wonder what stock prices will do when individual investors finally switch into the stock market, given how well it’s already done without much of their money.
So now we’re entering a new phase of the bull market. That the global economy is improving is now common knowledge (Australia raised interest rates in a surprise move today because the economy there is really heating up). This time around, the US is likely to be pulled up by other countries rather than leading the rebound. Where you invest, and what kinds of investments you choose, will become progressively more important. Just being bold and buying any beaten-down security is not likely to be so remunerative as it has been. And that’s a major reason behind the portfolio rebalancing that I’ve been doing lately, and will continue to do until I’ve positioned everyone as well as I can.
As always, somehow the world has made it through yet another financial crisis. Things should be a lot better for a while, until the next crisis, which likely will be far less severe than the one we just survived. But no amount of regulation will prevent bear markets, or financial panics, or recessions. You just can’t regulate human behavior, especially when ruled by emotion.
Maybe we should put Prozac in the drinking water instead of fluoride (just kidding).
Why are stocks doing so well? For that matter, why are bonds on a tear as well? We all know that the economy is on the skids, the financial system is still shaky, the real estate market is moribund and unemployment is nearing post-Depression highs. Banks are failing on a weekly basis owing to continuing loan defaults, particularly residential mortgages. Everyone knows that commercial real estate loans are next. US consumers remain stretched, and instead of borrowing more against their homes, are paying down debt and cutting back, both voluntarily and in response to tight credit. Massive layoffs, and fears of being laid off, are naturally exacerbating consumer cutbacks.
Yet through it all, stock prices continue skyward. Even the pullbacks have been relatively short and mild. The deepest drop since the March bottom was about –8%; the current one has only been about –4% so far. This, again, is typical of early bull markets: the first real correction of –10% or greater doesn’t usually occur for 12 to 18 months or more. By now you know that the stock market doesn’t react to the economy; rather, it anticipates it. Thus, the sharp rise in equity prices over the past 7 months points to an improving economy, and recent data confirm this view. So a rising market at this point should be no surprise.
Many people, however, worry that stocks have come too far, too fast. After all, a +69% jump in just a few months seems overdone. Surely, we must be due for a substantial drop, even if the economy continues to recover. And if we have a “double dip” recession, then a drop must certainly be in the cards.
The problem with this logic is that all of these risks are well known. Stock prices don’t react to known information, but only to surprises. And by definition, a surprise cannot be anticipated. Thus, the only thing that should cause a major change in the direction of the market is something bad that happens out of the blue. A major war with Iran could be in this category, although even that risk is starting to be discounted by the market. Continuing loan defaults and home foreclosures, lousy corporate earnings, sluggish consumer spending and rising unemployment are widely known problems that no longer have market-moving power.
Moreover, most of the surprises over the past several months have been of the positive variety. Corporate earnings are mostly better than predicted. GDP growth worldwide is coming in higher than expected. And the status of the banking industry is no longer dire. In fact, the European Union recently completed a “stress test” of its 22 largest banks (accounting for 60% of deposits in the EU) and found that they are in surprisingly good shape. None are likely to need additional capital even if the economy does much worse than expected (and yet, many are raising additional capital anyway, and successfully at that).
The other thing to keep in mind when looking at stock prices is that using the March 9 low as an anchor can be very misleading. Yes, stocks are up hugely since then, but the global bear market that took them to those lows was more severe than any since 1721 (and worse in the US than any since 1932). At the levels of this March, stock prices were pricing in a total meltdown of the financial system that never occurred. At their present levels, they are predicting a gradual recovery from a severe recession, yet remain –31% below their highs of 2007. Just to get back to those levels, the MSCI ACWI needs to rise +45% from here. This return trip will probably take another 3 years, which means the economy won’t be back to early 2008 levels until 2013. This may seem painfully slow, but it represents an annual return of over +15% including dividends—far more than you’re likely to receive from most other investments.
Over the past week or so, people have been focusing on the lousy employment numbers and what the very slow recovery of the job market might mean to the economy. The reasoning goes that we can’t see meaningful GDP growth while unemployment continues to rise and the consumer holds back. But history shows the fallacy of this reasoning: employment is one of the last indicators to turn positive, well after GDP has started growing again and the stock market recovered. During the past 4 recessions, employment didn’t start growing again until an average of 8 months after the stock market bottomed.
But job recovery keeps taking longer, for a variety of reasons. After the 1990 recession induced by the S&L crisis, for example, unemployment didn’t peak until 16 months after the market started to rebound, by which time it was already up +40% (and this after a relatively mild –20% bear market). Job recovery this time will likely take at least that long, meaning that we’re not likely to see a peak in unemployment until next July. And by then, stocks could well be significantly higher than today.
So while the gains in all asset classes have been impressive over the past several months, most investors missed it. They opted for “safe” investments such as CD’s, US Treasuries and money market funds, happy to earn 1% or even less. On top of this, most investors that were willing to take some risk did so with bonds rather than stocks: from March through mid-September, mutual fund investors put 20 times as much into bond funds as stock funds. (In contrast, during the preceding bull market, stock mutual funds received 2.5 times more money than bond funds.) One has to wonder what stock prices will do when individual investors finally switch into the stock market, given how well it’s already done without much of their money.
So now we’re entering a new phase of the bull market. That the global economy is improving is now common knowledge (Australia raised interest rates in a surprise move today because the economy there is really heating up). This time around, the US is likely to be pulled up by other countries rather than leading the rebound. Where you invest, and what kinds of investments you choose, will become progressively more important. Just being bold and buying any beaten-down security is not likely to be so remunerative as it has been. And that’s a major reason behind the portfolio rebalancing that I’ve been doing lately, and will continue to do until I’ve positioned everyone as well as I can.
As always, somehow the world has made it through yet another financial crisis. Things should be a lot better for a while, until the next crisis, which likely will be far less severe than the one we just survived. But no amount of regulation will prevent bear markets, or financial panics, or recessions. You just can’t regulate human behavior, especially when ruled by emotion.
Maybe we should put Prozac in the drinking water instead of fluoride (just kidding).
Saturday, September 5, 2009
September Song
Happy Labor Day! The summer’s nearly over, which means that Wall St. traders will be returning from their Hampton summer homes and getting back to work. Trading volumes should be much higher starting next week. And despite fears that September is the cruelest month for stocks (I don’t know about you, but I’m sick of hearing about it in the news), I see no reason for a big drop anytime soon. Minor pullbacks of –5% or so will continue to occur throughout the early phases of this new bull market, but a big drop of up to –20% seems highly unlikely.
I’ve given you many reasons over the past few months why I think the bear market is over and we’re in a new bull market that will not only reclaim the highs of 2007, but should surpass them. The former drivers of the bull market continue today: extremely low interest rates, low inflation, and rapidly normalizing credit spreads (3 month LIBOR is now 0.31%, the lowest in history). The bond yield curve continues to be very steep, with long-term interest rates far higher than short-term rates, which is great for banks, corporations and the economy, and of course for the stock market.
And don’t forget that there are still trillions of dollars in cash, money markets, CD’s and short-term Treasuries earning next to nothing. Money market balances alone are currently $3.58 trillion, which is equal to 34% of the entire stock market’s capitalization. Even after a +50% jump in equity prices from the March lows, this percentage is still higher than the 29% we saw near the market’s bottom in 2002. There’s also $3.5 trillion in bank checking and savings accounts, $trillions more in short-term Treasuries earning less than 1%, and $trillions in corporate bank accounts just itching to buy other companies. Thus there’s more than enough fuel to heat up the market for some time to come.
I remember back in the winter, people were arguing that stocks had to become as cheap on an absolute basis as they were in 1982 before we’d see a market bottom (although if you recall my March 10 article, they did become as cheap on a relative basis as in 1982 and 1932). Only then would investors be enticed to buy risky stocks in favor of safer investments. But this ignores an extremely important difference between 2009 and 1982: back then, you could earn 15% in totally safe short-term CD’s and US Treasuries. Why buy risky stocks with this kind of return from safe investments? Today, safe short-term investments earn 1% or less, making the long-term return from stocks that much more attractive.
On top of all the good news we’ve been hearing since the spring, including an apparent bottoming of the housing market and lots of corporations beating earnings estimates, another bull market driver arrived recently: the recession not only appears to be over, but the rebound is starting to look like the “V” everyone said couldn’t happen. What?! Could the terror of the last 2 years actually have been just a particularly long and deep recession rather than the end of the world or Great Depression II? And could the recovery and associated bull market be pretty normal, too, but perhaps even longer and stronger than average? Boy, wouldn’t this piss off the doomsayers! Only time will tell, but I wouldn’t be surprised to see economic growth of +4% or more for several quarters.
So during the Labor Day weekend, if you have to think about investments or the economy, look at the bright side. Forget about rising unemployment or an overleveraged consumer. As I’ve said recently, these are far less important to a recovery than the factors mentioned above. And by the time unemployment has fallen back to more normal levels and the consumer starts spending like crazy again, the bull market will be mostly over. When everybody’s happy and can’t see any clouds on the horizon is when I start to worry. But that’s obviously a long way off.
Party hearty (but healthfully)!
I’ve given you many reasons over the past few months why I think the bear market is over and we’re in a new bull market that will not only reclaim the highs of 2007, but should surpass them. The former drivers of the bull market continue today: extremely low interest rates, low inflation, and rapidly normalizing credit spreads (3 month LIBOR is now 0.31%, the lowest in history). The bond yield curve continues to be very steep, with long-term interest rates far higher than short-term rates, which is great for banks, corporations and the economy, and of course for the stock market.
And don’t forget that there are still trillions of dollars in cash, money markets, CD’s and short-term Treasuries earning next to nothing. Money market balances alone are currently $3.58 trillion, which is equal to 34% of the entire stock market’s capitalization. Even after a +50% jump in equity prices from the March lows, this percentage is still higher than the 29% we saw near the market’s bottom in 2002. There’s also $3.5 trillion in bank checking and savings accounts, $trillions more in short-term Treasuries earning less than 1%, and $trillions in corporate bank accounts just itching to buy other companies. Thus there’s more than enough fuel to heat up the market for some time to come.
I remember back in the winter, people were arguing that stocks had to become as cheap on an absolute basis as they were in 1982 before we’d see a market bottom (although if you recall my March 10 article, they did become as cheap on a relative basis as in 1982 and 1932). Only then would investors be enticed to buy risky stocks in favor of safer investments. But this ignores an extremely important difference between 2009 and 1982: back then, you could earn 15% in totally safe short-term CD’s and US Treasuries. Why buy risky stocks with this kind of return from safe investments? Today, safe short-term investments earn 1% or less, making the long-term return from stocks that much more attractive.
On top of all the good news we’ve been hearing since the spring, including an apparent bottoming of the housing market and lots of corporations beating earnings estimates, another bull market driver arrived recently: the recession not only appears to be over, but the rebound is starting to look like the “V” everyone said couldn’t happen. What?! Could the terror of the last 2 years actually have been just a particularly long and deep recession rather than the end of the world or Great Depression II? And could the recovery and associated bull market be pretty normal, too, but perhaps even longer and stronger than average? Boy, wouldn’t this piss off the doomsayers! Only time will tell, but I wouldn’t be surprised to see economic growth of +4% or more for several quarters.
So during the Labor Day weekend, if you have to think about investments or the economy, look at the bright side. Forget about rising unemployment or an overleveraged consumer. As I’ve said recently, these are far less important to a recovery than the factors mentioned above. And by the time unemployment has fallen back to more normal levels and the consumer starts spending like crazy again, the bull market will be mostly over. When everybody’s happy and can’t see any clouds on the horizon is when I start to worry. But that’s obviously a long way off.
Party hearty (but healthfully)!
Monday, July 27, 2009
How long should you keep financial records?
One of you asked how long one should keep tax returns, bank and brokerage statements, etc. Since I think this information will be of general interest to all of you, I decided to put it in one of my client emails. This information comes from a variety of sources, including my CPA wife, the IRS, the SEC and FINRA, the CFA Society and the AICPA, we well as KCS’s own practices. This is meant as a guide only and not the final word on the topic, as experts will often disagree (as they do in most things).
First, tax records. Backup for your tax returns, such as receipts, canceled checks for charitable contributions, bank and brokerage statements, 1099’s, W-2’s, etc. should be kept for 4 years after your return was filed (or the due date for the return if later). Thus, if you filed your 2008 taxes on April 15, 2009, you should keep all these records until April 14, 2013, at which point it is generally safe to shred them. If you had an extension and filed on Oct. 15, then you should keep your records until Oct. 14, 2013.
There are two exceptions to these guidelines: It’s usually a good idea to save the tax returns themselves forever, partly as proof of filing, and also for useful data in filing future returns. If this seems too long, then 10 years is a reasonable compromise. The second exception is evidence of the cost basis for investment property (stocks, bonds, real estate, etc.). These should be kept as long as you own the asset, then filed with the tax records for the year in which the asset was sold (and thus kept an additional 4 years). This can be a LONG time: I only recently sold shares of stock my father had bought in the 1950’s!
Evidence of the purchase cost of a financial asset can typically be found on your brokerage statement, as well as on the trade confirmation. The latter is usually easier to keep for a long period.
Insurance records, including policies and appraisals or purchase receipts for insured property, should obviously be kept at least as long as the policy is in force; it’s probably best to keep the policies themselves for at least 3 or 4 years after they’re canceled, along with the last year or so of policy statements. Purchase receipts should be kept at least as long as you intend to insure the property (if it’s also an investment asset, see above). Some say that old appraisals can be discarded once you have new ones, but others suggest keeping appraisals forever. The latter approach provides a history of the property’s value.
Lastly, there are things you should keep forever: copies of all versions of your living trust, other trust documents, wills, durable powers of attorney, healthcare advance directives, birth certificates, citizenship papers, medical records, diplomas and transcripts, marriage and adoption papers, divorce and separation agreements, and other really important papers. Note that regarding documents that are periodically updated (especially wills and living trusts), make sure that the latest version is always clearly indicated and readily available. You don’t want your executor mistakenly using an outdated document!
At this point, you’re probably thinking, “That a LOT of paper to keep!” And some of it should be stored in a safe place, such as in a safe deposit box. But for many documents, especially financial records and tax returns, there’s another option: electronic storage. That’s how we keep just about everything at KCS, including many of our clients’ records. As we look at expanding the kinds of client records we keep for your convenience, as well as how to make them readily available to you (such as over the Internet), here’s a rundown of what we currently keep on file and for how long:
Financial statements: For all accounts to which we have direct access, most obviously your Fidelity brokerage accounts, but also certain other types of investment accounts, we keep electronic versions of the statements for 7 years (as per SEC and CFA guidelines). Fidelity keeps 18 months accessible online through Fidelity.com (they also keep older statements, but we typically have faster access to them). We keep cost basis information as long as you own the asset, plus 7 years after you sell it.
In addition, we have transaction information in our portfolio management system back to when you first became a client of KCS. For those of you who were previously clients of Gay Abarbanell, we often have transaction information going back many more years. Access to this information can be surprisingly quick.
Any document that you have provided to us, either in electronic or paper form, is kept electronically for at least 7 years, and longer if it’s one of those “forever” documents listed above. Thus, if we don’t have the most recent copies of your living trusts, wills, insurance policies and other important papers, as well as tax returns going back several years, please don’t hesitate to send them to us for storage.
To get them to us, it’s obviously easiest if you have them in electronic format (PDF’s or TIFF’s are preferred). Some people are concerned that regular email could be intercepted, and we are looking into an easy and convenient means for you to email us encrypted documents. However, we host our own email server here, so that a hacker would have to grab an email during the brief time it’s in cyberspace, as our emails are not stored on any outside server that might be prone to hacking. So the odds of your email falling into the wrong hands, while not zero, are extremely low.
For paper documents, it’s best for you to send us a clean copy of the document that we can scan and then shred. We don’t recommend sending originals of important documents through the mail, but if you must do so, registered mail is best (we will return the documents by registered mail as well). Another option is to physically bring the documents to us, such as during one of your scheduled meetings; we can scan them and return the originals to you before you leave our offices.
Note that we’re not really a document storage service, so I’m not recommending that you discard originals of important records and documents just because we have them here. While we make frequent and multiple backups of all your data, I see having your documents at KCS more as an added failsafe and convenience to also keeping them yourself. On the other hand, if you have the ability to store electronic copies of documents that don’t necessitate keeping hard copy originals, we can provide you with PDF’s so that you can save storage space at home. (As always, back up your hard drives regularly, and also keep important documents on archival CDs or DVDs.)
So there you have it: more information than you probably ever wanted on record retention. But boring as it is, I’ll be this info will come in handy someday, perhaps when the IRS comes a-knocking.
Oh, by the way, the S&P 500 hit another new high for the year today. It’s now up about +6.5% so far in 2009. Not terrific, but a welcome change from 2008! Meanwhile, our benchmark, the MSCI ACWI [All-Country World Index], is up a much more impressive +17.2% so far this year, and a whopping +54% above its March 9 low. Yet despite these big recent returns, many are still denying that the bear market is over. What’s your opinion?
First, tax records. Backup for your tax returns, such as receipts, canceled checks for charitable contributions, bank and brokerage statements, 1099’s, W-2’s, etc. should be kept for 4 years after your return was filed (or the due date for the return if later). Thus, if you filed your 2008 taxes on April 15, 2009, you should keep all these records until April 14, 2013, at which point it is generally safe to shred them. If you had an extension and filed on Oct. 15, then you should keep your records until Oct. 14, 2013.
There are two exceptions to these guidelines: It’s usually a good idea to save the tax returns themselves forever, partly as proof of filing, and also for useful data in filing future returns. If this seems too long, then 10 years is a reasonable compromise. The second exception is evidence of the cost basis for investment property (stocks, bonds, real estate, etc.). These should be kept as long as you own the asset, then filed with the tax records for the year in which the asset was sold (and thus kept an additional 4 years). This can be a LONG time: I only recently sold shares of stock my father had bought in the 1950’s!
Evidence of the purchase cost of a financial asset can typically be found on your brokerage statement, as well as on the trade confirmation. The latter is usually easier to keep for a long period.
Insurance records, including policies and appraisals or purchase receipts for insured property, should obviously be kept at least as long as the policy is in force; it’s probably best to keep the policies themselves for at least 3 or 4 years after they’re canceled, along with the last year or so of policy statements. Purchase receipts should be kept at least as long as you intend to insure the property (if it’s also an investment asset, see above). Some say that old appraisals can be discarded once you have new ones, but others suggest keeping appraisals forever. The latter approach provides a history of the property’s value.
Lastly, there are things you should keep forever: copies of all versions of your living trust, other trust documents, wills, durable powers of attorney, healthcare advance directives, birth certificates, citizenship papers, medical records, diplomas and transcripts, marriage and adoption papers, divorce and separation agreements, and other really important papers. Note that regarding documents that are periodically updated (especially wills and living trusts), make sure that the latest version is always clearly indicated and readily available. You don’t want your executor mistakenly using an outdated document!
At this point, you’re probably thinking, “That a LOT of paper to keep!” And some of it should be stored in a safe place, such as in a safe deposit box. But for many documents, especially financial records and tax returns, there’s another option: electronic storage. That’s how we keep just about everything at KCS, including many of our clients’ records. As we look at expanding the kinds of client records we keep for your convenience, as well as how to make them readily available to you (such as over the Internet), here’s a rundown of what we currently keep on file and for how long:
Financial statements: For all accounts to which we have direct access, most obviously your Fidelity brokerage accounts, but also certain other types of investment accounts, we keep electronic versions of the statements for 7 years (as per SEC and CFA guidelines). Fidelity keeps 18 months accessible online through Fidelity.com (they also keep older statements, but we typically have faster access to them). We keep cost basis information as long as you own the asset, plus 7 years after you sell it.
In addition, we have transaction information in our portfolio management system back to when you first became a client of KCS. For those of you who were previously clients of Gay Abarbanell, we often have transaction information going back many more years. Access to this information can be surprisingly quick.
Any document that you have provided to us, either in electronic or paper form, is kept electronically for at least 7 years, and longer if it’s one of those “forever” documents listed above. Thus, if we don’t have the most recent copies of your living trusts, wills, insurance policies and other important papers, as well as tax returns going back several years, please don’t hesitate to send them to us for storage.
To get them to us, it’s obviously easiest if you have them in electronic format (PDF’s or TIFF’s are preferred). Some people are concerned that regular email could be intercepted, and we are looking into an easy and convenient means for you to email us encrypted documents. However, we host our own email server here, so that a hacker would have to grab an email during the brief time it’s in cyberspace, as our emails are not stored on any outside server that might be prone to hacking. So the odds of your email falling into the wrong hands, while not zero, are extremely low.
For paper documents, it’s best for you to send us a clean copy of the document that we can scan and then shred. We don’t recommend sending originals of important documents through the mail, but if you must do so, registered mail is best (we will return the documents by registered mail as well). Another option is to physically bring the documents to us, such as during one of your scheduled meetings; we can scan them and return the originals to you before you leave our offices.
Note that we’re not really a document storage service, so I’m not recommending that you discard originals of important records and documents just because we have them here. While we make frequent and multiple backups of all your data, I see having your documents at KCS more as an added failsafe and convenience to also keeping them yourself. On the other hand, if you have the ability to store electronic copies of documents that don’t necessitate keeping hard copy originals, we can provide you with PDF’s so that you can save storage space at home. (As always, back up your hard drives regularly, and also keep important documents on archival CDs or DVDs.)
So there you have it: more information than you probably ever wanted on record retention. But boring as it is, I’ll be this info will come in handy someday, perhaps when the IRS comes a-knocking.
Oh, by the way, the S&P 500 hit another new high for the year today. It’s now up about +6.5% so far in 2009. Not terrific, but a welcome change from 2008! Meanwhile, our benchmark, the MSCI ACWI [All-Country World Index], is up a much more impressive +17.2% so far this year, and a whopping +54% above its March 9 low. Yet despite these big recent returns, many are still denying that the bear market is over. What’s your opinion?
Tuesday, July 14, 2009
The time seems right‹Finally!
After a ferocious run through most of March, April and May, global equity markets stagnated for a while and then fell for about 5 weeks. The MSCI ACWI (All-Country World Index) peaked on June 2 at +48.6% above its March 9 low. It then spent most of the next 5 weeks drifting down, for a net loss of –7.6% from its recent peak as of last Friday. Investors became progressively more nervous during this period, with some measures of investor sentiment falling to levels not seen since mid-March, even though market indexes were at least 25% higher. Green shoots became brown weeds, and people again fretted over the speed and timing of an economic recovery. Several downbeat economic reports contributed to this feeling, and worries over earnings season, which began last week, added to the malaise.
Make up whatever reasons you want, the market just doesn't go up (or down) in a straight line. After a nearly +50% jump in just 12 weeks, stocks were due for a breather. A decline of 5–10% should have been expected. And that is the main reason I have been holding off investing cash and rebalancing portfolios recently, waiting for the correction to end, as I feel confident it will. And although it’s too early to know for sure, I suspect the end came yesterday, when the S&P 500 rose over +2% and erased its losses from the prior week.
Today, stocks edged up again, and after-hours action suggests another positive day tomorrow. The NASDAQ 100, for example, is up nearly +1.5% this evening, largely because of Intel’s positive earnings surprise. After the market closed today, the tech bellwether reported earnings and sales well above expectations; in fact, sales for the quarter were over $700 million more than analysts anticipated, and the company expects continued improvement in the third quarter. Intel stock is, not surprisingly, up over +7% after hours.
Yesterday’s powerful rally was ostensibly driven by the comments of Meredith Whitney, a prominent bank analyst who made a name last year by predicting hard times for banks. Far from her usual doom and gloom, yesterday she said that banks’ and other financials’ earnings in the second quarter would likely be much stronger than expected; Goldman Sachs’ announcement this morning that their earnings were +42% above expectations certainly added support to that view. Maybe the shoots are green after all.
Not surprisingly, the recently-ended second quarter of 2009 was one of the strongest for stocks in history, with the MSCI ACWI up +22.3% during those 3 months. Large numbers of investors who sold out of stocks in fear and disgust during February and early March ended up missing a history-making rally. These recent results are all the more impressive when you realize that the last time we had a positive quarter for stocks was way back in the third quarter of 2007 (when the MSCI ACWI was up only +3.5%)! It’s certainly been a long and horrific bear market!
But today I’m going to make three heretical statements, the kind I’ve been loath to make for well over a year now. Here are two predictions for the stock market and one for the economy:
1. The bear market that began on November 1, 2007 ended on March 9, 2009. Furthermore, the lows of that day will never be seen again (ever).
2. Stocks will continue to rise (in their usual irregular fashion) throughout this year and next. The MSCI ACWI will end 2009 at least +26% higher than today. 2010 should see another increase of +20% or more.
3. The recession that began in December 2007 is already over (at least as measured by changes in GDP). US GDP bottomed no later than June 2009. (We won’t know this “officially” until at least September.)
Many people will undoubtedly argue with me on these predictions, as well they should. But rather than giving me reasons why I might be wrong (or right), let’s just put these away until December 31 and see how I did.
Given the state of the markets and the economy right now, I think it’s finally time to buy stocks again. Those of you who have received your updated portfolios will start seeing trades in your accounts very shortly. Those who have not yet received your rebalanced portfolios will get them very soon. I wish I could do them all at once by computer, but because every client portfolio is a little different, and because I use a unique industry and country weighting approach, there is no software available that will do the trick (including those costing $100,000 or more). At some point, I hope to develop custom software to handle rebalancing; in the meantime, I will continue to use Excel and a lot of time and sweat!
Make up whatever reasons you want, the market just doesn't go up (or down) in a straight line. After a nearly +50% jump in just 12 weeks, stocks were due for a breather. A decline of 5–10% should have been expected. And that is the main reason I have been holding off investing cash and rebalancing portfolios recently, waiting for the correction to end, as I feel confident it will. And although it’s too early to know for sure, I suspect the end came yesterday, when the S&P 500 rose over +2% and erased its losses from the prior week.
Today, stocks edged up again, and after-hours action suggests another positive day tomorrow. The NASDAQ 100, for example, is up nearly +1.5% this evening, largely because of Intel’s positive earnings surprise. After the market closed today, the tech bellwether reported earnings and sales well above expectations; in fact, sales for the quarter were over $700 million more than analysts anticipated, and the company expects continued improvement in the third quarter. Intel stock is, not surprisingly, up over +7% after hours.
Yesterday’s powerful rally was ostensibly driven by the comments of Meredith Whitney, a prominent bank analyst who made a name last year by predicting hard times for banks. Far from her usual doom and gloom, yesterday she said that banks’ and other financials’ earnings in the second quarter would likely be much stronger than expected; Goldman Sachs’ announcement this morning that their earnings were +42% above expectations certainly added support to that view. Maybe the shoots are green after all.
Not surprisingly, the recently-ended second quarter of 2009 was one of the strongest for stocks in history, with the MSCI ACWI up +22.3% during those 3 months. Large numbers of investors who sold out of stocks in fear and disgust during February and early March ended up missing a history-making rally. These recent results are all the more impressive when you realize that the last time we had a positive quarter for stocks was way back in the third quarter of 2007 (when the MSCI ACWI was up only +3.5%)! It’s certainly been a long and horrific bear market!
But today I’m going to make three heretical statements, the kind I’ve been loath to make for well over a year now. Here are two predictions for the stock market and one for the economy:
1. The bear market that began on November 1, 2007 ended on March 9, 2009. Furthermore, the lows of that day will never be seen again (ever).
2. Stocks will continue to rise (in their usual irregular fashion) throughout this year and next. The MSCI ACWI will end 2009 at least +26% higher than today. 2010 should see another increase of +20% or more.
3. The recession that began in December 2007 is already over (at least as measured by changes in GDP). US GDP bottomed no later than June 2009. (We won’t know this “officially” until at least September.)
Many people will undoubtedly argue with me on these predictions, as well they should. But rather than giving me reasons why I might be wrong (or right), let’s just put these away until December 31 and see how I did.
Given the state of the markets and the economy right now, I think it’s finally time to buy stocks again. Those of you who have received your updated portfolios will start seeing trades in your accounts very shortly. Those who have not yet received your rebalanced portfolios will get them very soon. I wish I could do them all at once by computer, but because every client portfolio is a little different, and because I use a unique industry and country weighting approach, there is no software available that will do the trick (including those costing $100,000 or more). At some point, I hope to develop custom software to handle rebalancing; in the meantime, I will continue to use Excel and a lot of time and sweat!
Friday, June 5, 2009
You know we're in a bull market when....
You know we're in a bull market when....
General Motors, once the world’s largest corporation, files for bankruptcy protection, yet global markets rise 2.5%. That’s exactly what happened yesterday. At the same time, GM was kicked out of the Dow Jones Industrial Average after an 83-year stay, replaced by the much younger Cisco Systems. Perhaps even more a sign of the times, Citigroup is also getting the boot, to be replaced by Travelers Cos., its former subsidiary. (How’s that for poetic justice?)
That stocks rose strongly on such news continues to suggest that investors are looking forward rather than back. The demise of once mighty GM is being taken as a sign of progress, as old industries mature and downsize, while newer ones (as embodied by network router maker Cisco) continue to blossom. “Creative destruction” is necessary for economic progress, and it tends to accelerate during times of economic turmoil.
So in the midst of the worst recession since 1982, and perhaps since 1932, stocks continue to rally. Even after the strongest March and April in memory, stocks maintained their upward march in May, with the MSCI ACWI (All-Country World Index) adding another +10.0%. Stocks’ rise from their March bottom has been nothing short of impressive: the MSCI ACWI has surged +45.8% in the 59 trading days from March 9 through yesterday, and it’s actually up +9.5% for the year. Quite a turnaround from being down -24.9% year to date on March 9!
The skeptics abound, and that is good for stocks. Many investors still think the worst is ahead of us, and are waiting for this rally to fizzle and take stocks down a lot before committing their money. They are likely to have a very long wait. Even many of those who believe we’ve seen the lows for this cycle (as I do; in fact, I believe we’ve seen the lows for this century!) don’t expect stocks to rise much from here. They’ve got plenty of good reasons, too, from the slowing economy and the fragile financial system to the overleveraged consumer and surging unemployment. Many of their arguments are sound, yet stocks just keep going up. What gives?
I think that the current surge in stock prices comes from the realization that the Armageddon scenario, in which the world financial system melts down and we enter Great Depression II, is now off the table. 2009 is likely to be characterized by “just” a very severe recession and credit crunch, but nothing of the magnitude of the 1930’s or what many were imagining just a couple of months ago. And in that context, the current rapid rise in the stock market makes sense.
We’ve come down so far from the highs of 2007 that they now seem like meaningless numbers: investors have “anchored” to the recent lows rather than the more remote highs. In fact, just to bring stock prices back to where they were before the collapse of Lehman Bros. and AIG, before the Armageddon scenario first started to be priced into stocks, the MSCI ACWI would need to rise another +29% from here. At that level, stocks would again be pricing a severe recession, which is what we’re experiencing today.
So absent any new and unexpected economic shocks, it looks to me that stocks could rise another 30% or so before being fully priced. No real improvement in the economy or financial system is necessary; just the gradual adjustment of investors expectations to the current reality. Once we make it back to that level (perhaps by the end of this year), further progress will depend on the economy actually improving. Most agree that this will happen next year, and the pace of improvement will help determine the rate at which stocks continue to rise.
The biggest risk to a persistently rising stock market over the next year or so is a “double dip” recession, in which the economy improves for a few months but then starts to contract again. This has happened before and it could happen again. While such an an occurrence would almost certainly cause stocks to fall, history suggests that they will remain well above their recession lows (as they did in 1933, for example.)
I’m not expecting the double-dip scenario, but one must be prepared just in case. Such preparation does NOT mean getting out of stocks now, because that risks missing what could be a roaring bull market. Rather, it means being watchful and doing one’s best to spot a double dip early. But most important, it means not panicking should one occur and abandoning stocks just before the best part of the bull market. Those who did so in 1933 missed out on four of the best years in stock market history, and a real return of +436% over that period. I’m sure they felt pretty stupid in retrospect!
Let’s be smart and realize we can’t predict the future. But we can learn from the past, both recent and more distant. I’ve certainly learned a lot recently, and have adapted my investment style in response. Not huge changes, but incremental ones, because successful investing is an endurance contest, not a sprint.
General Motors, once the world’s largest corporation, files for bankruptcy protection, yet global markets rise 2.5%. That’s exactly what happened yesterday. At the same time, GM was kicked out of the Dow Jones Industrial Average after an 83-year stay, replaced by the much younger Cisco Systems. Perhaps even more a sign of the times, Citigroup is also getting the boot, to be replaced by Travelers Cos., its former subsidiary. (How’s that for poetic justice?)
That stocks rose strongly on such news continues to suggest that investors are looking forward rather than back. The demise of once mighty GM is being taken as a sign of progress, as old industries mature and downsize, while newer ones (as embodied by network router maker Cisco) continue to blossom. “Creative destruction” is necessary for economic progress, and it tends to accelerate during times of economic turmoil.
So in the midst of the worst recession since 1982, and perhaps since 1932, stocks continue to rally. Even after the strongest March and April in memory, stocks maintained their upward march in May, with the MSCI ACWI (All-Country World Index) adding another +10.0%. Stocks’ rise from their March bottom has been nothing short of impressive: the MSCI ACWI has surged +45.8% in the 59 trading days from March 9 through yesterday, and it’s actually up +9.5% for the year. Quite a turnaround from being down -24.9% year to date on March 9!
The skeptics abound, and that is good for stocks. Many investors still think the worst is ahead of us, and are waiting for this rally to fizzle and take stocks down a lot before committing their money. They are likely to have a very long wait. Even many of those who believe we’ve seen the lows for this cycle (as I do; in fact, I believe we’ve seen the lows for this century!) don’t expect stocks to rise much from here. They’ve got plenty of good reasons, too, from the slowing economy and the fragile financial system to the overleveraged consumer and surging unemployment. Many of their arguments are sound, yet stocks just keep going up. What gives?
I think that the current surge in stock prices comes from the realization that the Armageddon scenario, in which the world financial system melts down and we enter Great Depression II, is now off the table. 2009 is likely to be characterized by “just” a very severe recession and credit crunch, but nothing of the magnitude of the 1930’s or what many were imagining just a couple of months ago. And in that context, the current rapid rise in the stock market makes sense.
We’ve come down so far from the highs of 2007 that they now seem like meaningless numbers: investors have “anchored” to the recent lows rather than the more remote highs. In fact, just to bring stock prices back to where they were before the collapse of Lehman Bros. and AIG, before the Armageddon scenario first started to be priced into stocks, the MSCI ACWI would need to rise another +29% from here. At that level, stocks would again be pricing a severe recession, which is what we’re experiencing today.
So absent any new and unexpected economic shocks, it looks to me that stocks could rise another 30% or so before being fully priced. No real improvement in the economy or financial system is necessary; just the gradual adjustment of investors expectations to the current reality. Once we make it back to that level (perhaps by the end of this year), further progress will depend on the economy actually improving. Most agree that this will happen next year, and the pace of improvement will help determine the rate at which stocks continue to rise.
The biggest risk to a persistently rising stock market over the next year or so is a “double dip” recession, in which the economy improves for a few months but then starts to contract again. This has happened before and it could happen again. While such an an occurrence would almost certainly cause stocks to fall, history suggests that they will remain well above their recession lows (as they did in 1933, for example.)
I’m not expecting the double-dip scenario, but one must be prepared just in case. Such preparation does NOT mean getting out of stocks now, because that risks missing what could be a roaring bull market. Rather, it means being watchful and doing one’s best to spot a double dip early. But most important, it means not panicking should one occur and abandoning stocks just before the best part of the bull market. Those who did so in 1933 missed out on four of the best years in stock market history, and a real return of +436% over that period. I’m sure they felt pretty stupid in retrospect!
Let’s be smart and realize we can’t predict the future. But we can learn from the past, both recent and more distant. I’ve certainly learned a lot recently, and have adapted my investment style in response. Not huge changes, but incremental ones, because successful investing is an endurance contest, not a sprint.
Wednesday, May 20, 2009
The bull keeps on running....
After last week’s –5% drop in the S&P 500, many were already calling an end to this rally. But I don’t think it’s over yet: far from it. This move up is likely to continue—with inevitable pauses such as the one last week—for many more months and even years. I suspect that before the new bull market is finally over, and stocks again suffer a –20% or greater decline, we’ll not only have reclaimed the highs of October 2007, but should be well beyond them. With very rare exceptions, bull markets are much bigger than the bears that precede them. The main risk to I see now isn’t losing money, but missing out on big profits.
Of course, I could be wrong. But I’m not seeing any economic or financial signs that disturb me. Most of the latter are hugely positive; for example, 3-month LIBOR (the rate at which many banks lend to each other) is now 0.78%. This is the lowest level ever, and it has fallen from 1.10% only one month ago. If LIBOR were to drop to about 0.50%, that would mean the inter-bank lending market was back to normal. It’s possible we could see this in just a couple of months.
Investor sentiment, while way better than it was in early March, remains tepid. And last week’s market drop was enough to convince many that the bear market is not yet over. As recently as last night, few expected a rally today. Tokyo was down –2.4%, as were several other Asian markets. But India changed all that when it rocketed +17% shortly after the open, apparently giving strong approval to the winning party in the just-completed election. Almost immediately, other Asian markets that were still open (Tokyo was closed) turned strongly positive, and the bull was reinvigorated. All this shows that markets can shift suddenly for little apparent reason.
Some of you are still waiting to see your re-allocated portfolios; most who have received them so far have had no comment (either you think they’re terrific or I’ve totally confused you). To all of you: don’t worry about missing the bull, we’ve got plenty of upside ahead of us. Just returning to the old highs on the S&P 500 would give us a +73% rise from here, and that’s without dividends. Allocating wisely among countries, industries and individual securities could provide even better results: non-US developed markets need to rise +87% (without dividends) to reclaim their 2007 highs, for example, and many individual stocks (such as GE) need to triple (that’s +200%) just to reach their old highs.
What’s driving the rally? There’s just too much cash out there, and cash isn’t earning squat. After inflation and taxes, nearly all so-called “risk free” investments are earning negative returns. If investors want to make a reasonable return in this environment, they simply have to take some risk. And in a nearly perfect reversal of the bear market, since their recent lows, riskier investments have provided higher returns than less risky ones. The risk-return relationship is again positive, as it has typically been over the long term.
Here’s a note from STIR Research on how institutional investors are dealing with their mounds of cash (written just before today’s big jump):
“According to this week’s Barron’s, growth stock managers have been left behind the last two months. Only 33% beat the benchmarks in March and only 25% in April. They want to catch up, and with high levels of cash, they are looking to buy on any dip.
“But the market has not been very accommodative. Last week we had 4 down days for the S&P 500, NASDAQ, the Russell 2000 and others. But on three of those down days volume was below normal. Even with Friday’s option expiration, which normally leads to a spike in volume, it was below average.
“We are interpreting that to mean, that even when the buyers pull back, sellers are not panicking and dumping stocks. Instead the selling has been drying up. Therefore, institutional investors wanting to deploy some of their excess cash, have to bid stocks higher to find willing sellers: a formula for a market moving higher.
“In a bullish report sent out Friday by Goldman Sachs, they noted that following the 18 largest bear markets in history, the initial rally lifts stocks 43% and lasts 180 days. And that is just the average.”
The last point is interesting. Given that the recent bear market was at least 50% worse than average, one could expect the initial rally to be roughly 50% stronger than average. This would imply that 6 months after its low, the S&P 500 would rise +65%, which translates into a level of 1,100 (compared to 910 today, or another +21% gain over the next 3 1/2 months). I’m not saying that this is what will happen, but it wouldn’t be out of line historically. Of course, if the global economy and credit markets are in decent shape by September, stocks should continue to move upward.
Remember that stocks are not the only “risky” asset. Corporate and municipal bonds, commodities, and real estate all fall into the risky asset category, and should also do well as the financial markets improve. They, too, deserve a place in most portfolios (and my model portfolios do include them). The only assets I would avoid right now are US Treasuries, CD’s and other “risk-free” assets. They should lag severely, and could even provide negative returns going forward.
Of course, I could be wrong. But I’m not seeing any economic or financial signs that disturb me. Most of the latter are hugely positive; for example, 3-month LIBOR (the rate at which many banks lend to each other) is now 0.78%. This is the lowest level ever, and it has fallen from 1.10% only one month ago. If LIBOR were to drop to about 0.50%, that would mean the inter-bank lending market was back to normal. It’s possible we could see this in just a couple of months.
Investor sentiment, while way better than it was in early March, remains tepid. And last week’s market drop was enough to convince many that the bear market is not yet over. As recently as last night, few expected a rally today. Tokyo was down –2.4%, as were several other Asian markets. But India changed all that when it rocketed +17% shortly after the open, apparently giving strong approval to the winning party in the just-completed election. Almost immediately, other Asian markets that were still open (Tokyo was closed) turned strongly positive, and the bull was reinvigorated. All this shows that markets can shift suddenly for little apparent reason.
Some of you are still waiting to see your re-allocated portfolios; most who have received them so far have had no comment (either you think they’re terrific or I’ve totally confused you). To all of you: don’t worry about missing the bull, we’ve got plenty of upside ahead of us. Just returning to the old highs on the S&P 500 would give us a +73% rise from here, and that’s without dividends. Allocating wisely among countries, industries and individual securities could provide even better results: non-US developed markets need to rise +87% (without dividends) to reclaim their 2007 highs, for example, and many individual stocks (such as GE) need to triple (that’s +200%) just to reach their old highs.
What’s driving the rally? There’s just too much cash out there, and cash isn’t earning squat. After inflation and taxes, nearly all so-called “risk free” investments are earning negative returns. If investors want to make a reasonable return in this environment, they simply have to take some risk. And in a nearly perfect reversal of the bear market, since their recent lows, riskier investments have provided higher returns than less risky ones. The risk-return relationship is again positive, as it has typically been over the long term.
Here’s a note from STIR Research on how institutional investors are dealing with their mounds of cash (written just before today’s big jump):
“According to this week’s Barron’s, growth stock managers have been left behind the last two months. Only 33% beat the benchmarks in March and only 25% in April. They want to catch up, and with high levels of cash, they are looking to buy on any dip.
“But the market has not been very accommodative. Last week we had 4 down days for the S&P 500, NASDAQ, the Russell 2000 and others. But on three of those down days volume was below normal. Even with Friday’s option expiration, which normally leads to a spike in volume, it was below average.
“We are interpreting that to mean, that even when the buyers pull back, sellers are not panicking and dumping stocks. Instead the selling has been drying up. Therefore, institutional investors wanting to deploy some of their excess cash, have to bid stocks higher to find willing sellers: a formula for a market moving higher.
“In a bullish report sent out Friday by Goldman Sachs, they noted that following the 18 largest bear markets in history, the initial rally lifts stocks 43% and lasts 180 days. And that is just the average.”
The last point is interesting. Given that the recent bear market was at least 50% worse than average, one could expect the initial rally to be roughly 50% stronger than average. This would imply that 6 months after its low, the S&P 500 would rise +65%, which translates into a level of 1,100 (compared to 910 today, or another +21% gain over the next 3 1/2 months). I’m not saying that this is what will happen, but it wouldn’t be out of line historically. Of course, if the global economy and credit markets are in decent shape by September, stocks should continue to move upward.
Remember that stocks are not the only “risky” asset. Corporate and municipal bonds, commodities, and real estate all fall into the risky asset category, and should also do well as the financial markets improve. They, too, deserve a place in most portfolios (and my model portfolios do include them). The only assets I would avoid right now are US Treasuries, CD’s and other “risk-free” assets. They should lag severely, and could even provide negative returns going forward.
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