Progress report

Six months have come and gone now since the financial crisis went code red and TARP I was rolled out in response. It's natural to wonder, then, how the government is doing in responding to the problem.

Unfortunately, the answer has to be "not well."

Below are two excerpts. The first is from the very first blog post SMI put up about the Treasury bailout plan (last Sept 23). The second is from Jon Markman's latest column, written last week. See if you can find the common thread.

From the SMI Weblog last September:

But there are key details still being hammered out, and this leads us back to the baseball card story. The problem is that nobody knows exactly what these potentially bad loans should be priced at. The financial institutions have them "marked" at a certain price, but that price is almost certainly too high, as most of them would love to unload them but can't because there aren't any buyers at the prices these bad loans are supposedly currently "worth." Like my dad told me, it's not worth the value in the price guide if there isn't anybody willing to pay you that amount.

There is some recent precedent for what these loans are worth, as there have been some fire sales of late for similar assets. In most of these cases, the bad debt was sold for something like 20-30 cents on the dollar.

So there are basically three prices in play in the current discussions.

The "hold to maturity" price would be the highest. This price assumes the debt won't default and the payments will be made as scheduled for the loan's life. We all know this isn't happening. If it were, there'd be no current crisis.

The "mark to market" price is closer to reality, but still likely to be considerably inflated.

And then there's the "auction" price, or what those assets would bring if they were sold on the open market. It's not entirely true that there are no buyers for this stuff currently. There just aren't any buyers at the prices the financial institutions are willing to sell at. That's not necessarily them being unrealistic or greedy. It's a realization that if they sell at the lower prices an "auction" would bring, they would need to raise more capital in order to stay in business - and might not be able to do it.

The Treasury bailout plan is drawing a lot of heat from a broad range of critics, over a range of different issues. But probably the biggest one is this: what price is the government going to pay for these assets? The one that makes the most sense would seem to be the auction price. That way the taxpayer (government) takes on the least risk and has the potential to benefit as the crisis ends and at least some of these loans come up in value a bit.

Unfortunately, buying the bad debt at the auction price doesn't help the banks any. If they were willing to sell at that price, they could likely already sell the stuff now, as there are vultures out there willing to buy these assets at bargain bin prices (at least according to some reports). The banks are still stuck having to raise huge amounts of capital in that scenario, which most of them are unable to do.

From Jon Markman's column last week:

There are also questions over the quality of loans and securities the banks will put up for sale and the prices they will accept. There is already a very active market for these securities — the government isn't starting from scratch — but banks have been unwilling to let them go for what investors are willing to pay. If you assume most of these loans and securities started life being worth the equivalent of $100, most are now being carried on banks books at around $80. The government would be happy to buy them with its funny money at $80 as a sneaky way to recapitalize banks without nationalizing them, but real-money investors in recent months have been willing to pay only $25 to $35.

If all the loans were really bought at $35, experts tell me, most banks would have to take losses large enough to send them into bankruptcy. Not good. So using government-subsidized loans, BlackRock and its peers appear willing to pay around $40 to $50, but they can't pay much more because they still need to mark them up and sell them to clients at pension funds who know full well that the loans are superrisky. Don't forget that underlying each CDO and loan are hundreds of real, live homeowners who might lose their jobs next month and stop paying their mortgages. The more investors pay, the longer they will need to wait for a good return.

Presumably, the best securities will go first, so the most interesting juncture in this whole drama will come a few weeks after it starts, when fund managers balk at paying $50 and banks won't take the bids at $35. My guess is that if and when the auctions start to lock up, a lot of bank stocks are going to get hammered, and there will be renewed talk of nationalization.

Scary, huh? The central problem six months ago is still the problem vexing the government-sponsored solution today: What price to put on these toxic loans? Six months have gone by, yet we're really no closer to resolving this central problem.

Ultimately, I don't believe the government is going to be able to "fix" this issue with taxpayer money. I think it will eventually take "nationalizing" some of these banks (i.e., allowing them to go through a government-arranged bankruptcy where they continue to function and service customers while wiping out the shareholders and giving the bondholders a nasty haircut) in order to write-down their massive debts to zero.

While that's an ugly option, it's not any worse than saddling the productive citizens of the U.S. with massive additional tax burdens for decades to come as a result of issuing huge new amounts of debt. I'd argue that it's actually much more just and appropriate. But that's still politically too unpalatable, so we'll continue to spin our wheels and spend huge gobs of money shooting for a quick fix.

Posted by Mark at 3:07 PM
Category(s): Current Market Events, Economy

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Tyrannosaurus Debt

With the Congressional Budget Office projecting (PDF) that President Obama's budget will produce $9.3 trillion worth of red ink over the next 10 years, it's time for a blast for the past: "Tyrannosaurus Debt," from the 1970s-era series Schoolhouse Rock.

It's fun — but not funny.

Posted by Joseph at 2:35 PM
Category(s): Economy, Taxes

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"Because the Lord is my Shepherd, I have everything I need!"

My final blog of last week was a downer, so thought we'd finish this time on an up note. Here's the latest in our weekly series of encouraging passages from the Psalms. This week's selections are from Psalms 21-33 (TLB):

Because the Lord is my Shepherd, I have everything I need! ... He gives me new strength. He helps me do what honors him the most.... Your goodness and unfailing kindness shall be with me all of my life, and afterwards I will live with you forever in your home. From Psalm 23

Show me the path where I should go, O Lord; point out the right road for me to walk. Lead me; teach me; for you are the God who gives me salvation. I have no hope except in you.... The Lord is good and glad to teach the proper path to all who go astray; he will teach the ways that are right and best to those who humbly turn to him. And when we obey him, every path he guides us on is fragrant with his loving-kindness and his truth. From Psalm 25

The Lord is my light and my salvation; he protects me from danger—whom shall I fear? ... Don’t be impatient. Wait for the Lord, and he will come and save you! Be brave, stouthearted, and courageous. Yes, wait and he will help you. From Psalm 27

Let your favor shine again upon your servant; save me just because you are so kind! ... Oh, how great is your goodness to those who publicly declare that you will rescue them. For you have stored up great blessings for those who trust and reverence you.... So cheer up! Take courage if you are depending on the Lord. From Psalm 31

Let all the joys of the godly well up in praise to the Lord, for it is right to praise him.... For all God’s words are right, and everything he does is worthy of our trust. He loves whatever is just and good; the earth is filled with his tender love.... No wonder we are happy in the Lord! For we are trusting him. We trust his holy name. Yes, Lord, let your constant love surround us, for our hopes are in you alone. From Psalm 33

Posted by Austin at 5:02 PM
Category(s): Christian Interest

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Battle plan for reinvestment

I see some familiar thoughts expressed in this interview with Jeremy Grantham:

Grantham recommends that each of us devise a detailed plan now of when we will put new money into the stock market: "You absolutely must have a battle plan for reinvestment and stick to it."

A corollary of this recommendation is that we accept that we won't catch the exact day of the bottom. Perfection is the enemy of the good here, since the pursuit of perfection actually is a "snare and a delusion: it will merely serve to increase your paralysis.

One of the biggest concerns I had in writing this month's cover article is that it might lead some readers to act defensively here (i.e., sell stocks), only to then have them stay fearfully on the sidelines until stock prices were much higher at some point in the future. While it may feel good to reduce your stock market exposure during a bear market, you obviously aren't being well served by selling at Dow 7,500 and buying back in at Dow 9,000.

That's why I tried to emphasize that anyone doing any selling this late in the bear market should establish up front a trigger for getting back into the market. The all-clear signal is a good tool, but slow. It's probably more appropriate for those who reduced their stock allocations way back in January 2008 when the bear-alert was triggered.

For those making adjustments now, a better approach is probably to draw a "line in the sand." The line in the sand approach is to simply pick some level around the point at which you sell that will force you back into stocks. For example, if you sell at Dow 7,500 you might resolve to buy back in if the market should move above Dow 8,000. (You could simply draw your line at the level at which you sell, except that a quick move above that point could whipsaw you into buying immediately after selling. So it's probably smart to build in a margin of at least a few percent to avoid that.)

Anyone who reduced stock exposure earlier in this bear market should also be going through mental exercise of determining what will cause you to get back into stocks. You may have made a brilliant move by getting out a year ago, but you need to follow that up with an intelligent decision of when to re-enter.

I'm not oblivious to the recent market conditions, and I recognize that most readers probably aren't inclined to take defensive actions fresh on the heels of a 20% spike in stock prices. Nor am I encouraging them to! Truth be told, my preference for the cover article would have been to just write "Hold on, you're probably better off not selling anything this late in the bear market." But that would have ignored the fact that just three short weeks ago, many investors were throwing in the towel. It's not a stretch to think that a couple of weeks of sharp losses would bring many investors right back to that point.

So, if you were one of those who, just a few weeks ago, were seriously questioning whether you should sell some of your stock holdings, you need to take advantage of the oxygen provided by the recent gains. Those gains help give you the ability to think more clearly and rationally about what your best approach will be IF this turns out to be a bear market rally and things start heading south again. If you think through the mental exercise now while your head is unclouded by fear, you'll probably make a better decision than if you wait until the market is retesting the early-March lows.

Of course, we can all relax if the market keeps going up, up, and away. But better to be prepared and not need that contingency plan than to need it and not have it.

Posted by Mark at 2:04 PM
Category(s): Current Market Events, Investing Principles

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Exploding 529 plans

Last month, we wrote about how many target-date mutual funds failed to protect those with short investing time frames last year. For those assuming they were invested conservatively based on the fact that their target date was only a year or two away, it was a cruel realization indeed to find losses of 20%, 30%, or even more.

In a similar vein, it turns out that some college saving 529 plans posted awful returns last year, even for those investors who were very close to college age. Most 529 plans allow investors to select an age-based investment track that is supposed to automatically get more conservative as the student approaches college age. Sadly, there's significant variation between plans as to how these allocation percentages shift, as well as the underlying funds they are invested in.

Thankfully, it appears that most of those who followed SMI's advice on selecting a good 529 plan would have steered clear of the worst disasters. Those most at risk would likely have been those who were enticed by generous matching provisions or other offers by their home state plan (if that plan turned out to be one of the offenders). Beyond that, a focus on the plan asset allocation options would have been healthy, and I suspect that those who went with plans featuring low-cost index funds avoided the worst of the damage.

Both the 529 and Target-date fund issues are a good reminder of a crucial investing fact: Nobody cares about your money as much as you do — so make sure you understand what you're investing in.

Posted by Mark at 3:26 PM
Category(s): College

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Straight talk

As I noted in the new issue email announcement yesterday, the past two weeks have been pretty dramatic. The S&P 500 rallied 23.5% from the low on March 6 through yesterday's close, the biggest 10-day gain since 1938.

Uh-oh. Did I say 1938? Because we all know some pretty crazy stuff happened with stocks in the 1930s.

Here's the deal, as plainly as I can put it. We all hope the bottom is in on this bear market. But bear markets are famous for these sorts of furious rallies, en route to further losses. Big bear market rallies are typically violent and exciting, keeping hope alive.

And as this great Barron's interview (which we linked to a month ago when investor emotion was 180 degrees the opposite of today) points out, the stock market had 6 rallies like this one (20% or more) between the 1929 peak and the eventual 1932 low. Each time, the gains were erased as the economy weakened further.

So just as we have often told you to take bad market news with a grain of salt, we'd suggest not getting too high based on the results of the past 10 days. Enjoy it, sure. We are! But don't pin your hopes on it.

There's certainly a chance this bear market put in its final low on March 6 (at the never-more-appropriate 666 level on the S&P 500). The fact that I'm seeing very, very few writers even willing to hint at that possibility is probably as positive an indicator as any.

But there's also a chance that this is just a bear market rally. If that's the case, giving back these recent gains could be potentially heartbreaking. Just the sort of pain that causes many investors to give up and sell. This late in the game, that could be a tragic mistake for some, which is actually one of the main points of this month's cover article.

If the market continues going up, everybody is happy. But if it comes back down, I want you to be prepared emotionally (the point of this post) and tactically (the point of this month's cover article). Hopefully the big gains of the past two weeks will make it a little easier to think objectively about your best course of action should the bear market resume.

Posted by Mark at 1:45 PM
Category(s): Current Market Events

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Sad news for Upgraders

One of the bigger (and better performing) no-load fund families is abandoning the no-load approach. Janus funds will be adding loads this summer.

Disappointing, as we've often loaded up on Janus funds during past bull markets.

Posted by Mark at 12:03 PM
Category(s): Mutual Funds

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Free gift book for blog readers (while supplies last)

In celebration of Christmas 2003, I offered John Piper's The Dangerous Duty of Delight to SMI readers. It's an adaptation of his Desiring God book, one that was wonderfully meaningful to me during some difficult days in the late 1980s. Perhaps this message would be encouraging to some of you during these challenging financial times and/or as an Easter meditation.

It's come to my attention that we have about 50 of these still on hand. I'm offering them to our blog readers on a first come, first serve basis. You can read more about the book, along with reader reviews both pro and con, here.

If you are interested in reading this book and would like to request a free copy, email your request to feedback@soundmindinvesting.com. Please include your name and mailing address (U.S. addresses only) and put "Piper Gift Book" in the subject line. Enjoy it with my best wishes.

Update: Boy, you blog readers are a very spiritual group (or you just like free stuff). One-half of the books were gone within a few hours of the posting, and the rest were claimed overnight. Sorry, but we had more requests than books available. The books are going out today, and should be arriving within the next week. If you asked but didn't receive, take heart ... there'll be another book offer in the next month or two.

Posted by Austin at 11:54 AM
Category(s): Christian Interest

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April issue now available

The April 2009 issue of the newsletter has just been posted to the website. You can browse all of the new content via the table of contents page.

Readers following our Fund Upgrading strategy are advised that two funds are being replaced this month.

Web members can read the write-ups of the new funds we're adding here.

Posted by Mark at 2:57 PM
Category(s): SMI General Announcements

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Gimme shelter

After my rather lengthy (and financially depressing) post on Friday, one member commented: "I already knew it was bad and getting worse. What I keep hoping to see in my financial newsletter are a variety of protection strategies." I thought an answer was worth its own post.

First, I will point out, as always, that the Four Levels process, if followed faithfully, is the best "protection strategy" for the average SMI member. Being debt-free and having sufficient emergency savings will go a long way to seeing anyone through the present crisis.

Second, following our allocation recommendations, based on one's age and risk tolerance, would also have protected those who test out as being risk-averse from major damage. Here are the 2008 results for various age/risk combinations (keeping in mind the market was off -37% last year):

5-10 years until retirement / Researcher temperament / 60/40 = ~21% loss
5-10 years until retirement / Preserver temperament / 50/50 = ~17% loss
5 years until retirement / Researcher temperament / 50/50 = ~17% loss
5 years until retirement / Preserver temperament / 40/60 = ~13% loss
Early retirement years / Researcher temperament / 40/60 = ~13% loss
Early retirement years / Preserver temperament / 20/80 = ~4% loss
Later retirement years / Researcher temperament / 20/80 = ~4% loss
Later retirement years / Preserver temperament / 0/100 = ~5% gain

If you have more than 10 years before retirement, it remains our belief that you have sufficient time to recover your losses. But if you don't necessarily buy that and want to brace for further market weakness, that brings us to...

Third, the cover article in the April issue, due out for web members this afternoon, will discuss Protecting Yourself Against "The Big One." In it, Mark offers age-based suggestions for those wishing to take further defensive steps.

Posted by Austin at 1:42 PM
Category(s): SMI Model Portfolios

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Valuation

This thought from the latest issue of No Load Fund*X is insightful:

"Global stock market prices have returned to where they were ten years ago, yet global GDP and earnings are about double where they were."

That certainly doesn't mean they can't go lower, but it does show how much more value stocks have now than when they were last at these levels ten years ago.

Posted by Mark at 3:00 PM
Category(s): Current Market Events

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"Bracing for a depression"

"American consumers are hunkered down, bracing for a depression," said Britt Beemer, chief executive of America's Research Group. "The dramatic drops in shopping levels have no match in our database in the last 30 years."

That's the takeaway of this MarketWatch article detailing the serious changes in consumer spending, saving, and other financial behavior happening in the U.S. right now.

It's not a pretty picture. But it's hard to look at a massive shift toward lower spending, paying off debt, increasing savings, etc. and not see that as a positive long-term development. In the short-term, it hurts like crazy. But in the long-term, it would seem these changes should put our economy on a healthier footing than the quicksand of debt we've been building on for some time now.

Posted by Mark at 10:54 AM
Category(s): Family Finances

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The guilt economy

How many families are currently making financial decisions, in part, due to the effects they know cutting back would have on those "down stream" from their spending?

The Wall Street Journal takes an interesting look at the new "Guilt Economy."

As Christians, it doesn't strike me as wrong to take into account the impact our decisions will have on those with whom our lives intersect. Obviously though, there have to be some qualifications on that. The seriousness of your own financial condition is a very big one. But so is listening to the leading of the Holy Spirit.

How many of you are currently struggling with "guilt economy" decisions? I'm interested in your thoughts.

Posted by Mark at 3:46 PM

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Taxing AIG bonuses

I get the outrage over the AIG bonuses. But it makes me very queasy to see Congress decide over the course of just a few days to pass a massive tax against a tiny, targeted group of people, for no other reason than they can claim popular support for it. Talk about an invitation to future abuse of power.

If this goes through, who is the next group to suddenly find that 70% of their compensation is going to be yanked away? You're kidding yourself to think it will be a one-time event if this precedent gets established.

Update: Austin, here. I'd forgotten, if I ever knew, that the Constitution prohibits bills of attainder. According to Dow Jones:

Lawmakers who vented their anger against American International Group Inc. (AIG) managers this week - and there were many - might find their words turned against them in an eventual constitutional challenge to legislation on AIG bonuses, should the bill become law. (More...)

Posted by Mark at 9:15 AM
Category(s): Taxes

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An extra $10 a week

Tax blogger Kay Bell has been running the numbers and she's figured out that most of us should start getting an extra $10 a week in our paychecks starting April 1.

The extra take-home pay is one result of the $787,000,000,000 "stimulus" bill signed into the law last month.

Why $10 and not $13 as announced earlier? Because the earlier estimate assumed the IRS wouldn't be able to roll out the required change in the withholding tables until June, meaning the $400 tax cut would be spread over seven months (June-December).

But the IRS was quicker on the draw than expected, so the rollback will be spread over nine months instead (April-December).

The tax reduction starts phasing out at $75K of income for single taxpayers and at $150K for married taxpayers filing jointly. That means higher-income taxpayers will see an increase of less than $10 a week — or perhaps no increase at all.

Posted by Joseph at 4:19 PM
Category(s): Family Finances

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What is normal?

Last month, I wrote an article explaining there's no such thing as normal when it comes to stock market investing. Apparently Don Hays has started reading SMI (okay, maybe not) as this is how he started his report yesterday:

In this volatility I just crave from time to time to get back to normal. Oh Yeah? Right!! What in the world is normal? Obviously the last 15 months have not been normal, but what about the 2 years before that. Do you think the 3 years before that were normal, with the worst hurricane season in a 100 years virtually wiping out New Orleans on the Gulf Coast? Do you think the entry in a global society by the new elephant China created normal conditions, or oil going from $10 a barrel to $147 a barrel? Do you think an amazing renaissance of the U.S. from a broke, unproductive dying economy in 1980 to the only Super-Power in the world was normal? How about the renaissance of the computer, and bio-technology, and how it has changed our lives in the last 15 years? Is it normal for the yield on the t-bill go from 17% to 0% in the last 30 years?

Posted by Mark at 4:11 PM
Category(s): Current Market Events

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"My contentment is not in wealth but in seeing you and knowing all is well between us."

Last week, in a reminder that we are to keep our eyes up, I posted the first in a series of encouraging passages from the Psalms. This week's selections are from Psalms 11-20 (TLB):

The Lord is still in his holy temple; he still rules from heaven. He closely watches everything that happens here on earth.... For God is good, and he loves goodness; the godly shall see his face. From Psalm 11

I will always trust in you and in your mercy and shall rejoice in your salvation. I will sing to the Lord because he has blessed me so richly. From Psalm 13

Save me, O God, because I have come to you for refuge. I said to him, "You are my Lord; I have no other help but yours." ... The Lord himself is my inheritance, my prize. He is my food and drink, my highest joy! He guards all that is mine. He sees that I am given pleasant brooks and meadows as my share! What a wonderful inheritance! I will bless the Lord who counsels me; he gives me wisdom in the night. He tells me what to do. I am always thinking of the Lord; and because he is so near, I never need to stumble or to fall. Heart, body, and soul are filled with joy.... You have let me experience the joys of life and the exquisite pleasures of your own eternal presence. From Psalm 16

My contentment is not in wealth but in seeing you and knowing all is well between us. And when I awake in heaven, I will be fully satisfied, for I will see you face to face. From Psalm 17

Lord, how I love you! For you have done such tremendous things for me. The Lord is my fort where I can enter and be safe... What a God he is! How perfect in every way! All his promises prove true. He is a shield for everyone who hides behind him. For who is God except our Lord? Who but he is as a rock? From Psalm 18

God’s laws are perfect. They protect us, make us wise, and give us joy and light. God’s laws are pure, eternal, just.... they warn us away from harm and give success to those who obey them.... May my spoken words and unspoken thoughts be pleasing even to you, O Lord my Rock and my Redeemer.
From Psalm 19

Posted by Austin at 2:33 PM
Category(s): Christian Interest

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Money-saving tips roundup

Some resources for your money-saving pleasure:

Save $50 a Day: This piece in Kiplinger's gives us penny pinchers some advice on saving money in small, painless ways. The money-saving tips are categorized for your convenience.

Feedflix.com: Get your money's worth out of your Netflix membership. Create a free account and link it to your existing Netflix account and you can see how much you're paying per DVD rental, average rental time, DVD returns by week and more.

CheckingFinder.com: Here's an alternative resource to Bankrate.com. Simply type in your zip code and find bank account interest rates in your area.

As always, we love hearing from our readers. If you have any sites that have been helpful to you, please share.

Posted by Matthew at 4:49 PM
Category(s): Family Finances

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Proposed changes in the charitable-giving deduction

The Planned Giving Design Center has an easy-to-understand write up about how President Obama's proposed tax changes could affect wealthy givers.

The Obama plan would limit the tax rate at which high-income taxpayers can take itemized deductions to 28 percent (down from the current 33 or 35 percent, depending one's bracket).

Example: A couple...in the 35 percent bracket gives $100,000 to charity. Under current law (presuming they can deduct the entire $100,000 in the year of transfer under the charitable percentage limitation rules), they will reduce their income taxes by $35,000. The net cost of their gift will be $65,000.

Under the Obama plan, the couple will only be able to deduct their gift at the 28 percent rate, thereby reducing their taxes by $28,000. In essence, they will pay an additional $7,000 in tax for the privilege of making their gift, thereby increasing the after-tax cost of their gift to $72,000 — a 10.8 percent increase over current law.

And when the Bush tax cuts expire after 2010, it will cost donors in the top bracket of 39.5 percent an additional $11,500 to make a $100,000 gift. This represents a 19 percent tax on giving — not to mention possible implications on state income tax.

The article includes a bit of history about why Congress, in 1917, created the charitable-giving deduction.

"The government concluded it was more efficient for individuals to give directly to charity rather than having the government tax individuals and then fund the services provided by those organizations," according to Barlow T. Mann, a planned-giving consultant with the Memphis-based Sharpe Group.

President Obama's plan for changing the contours of the charitable-giving deduction isn't a done deal, of course. The plan is meeting stiff resistance in Congress — and not just from Republicans.

MarketWatch has the story.

Posted by Joseph at 1:30 PM
Category(s): Giving and Stewardship, Taxes

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"Those who know your name trust in you..."

The mood of the market is dark. The mood of many SMI members is darker. Time to raise our eyes and look at our blessings and the One who has promised to protect and provide.

I've been reading in the Psalms (NLT) of late, and have selected various passages to pass along to you each week for a while. My hope is that you will be encouraged and strengthened. This week, from Psalms 1-10:

Oh, the joys of those who ... delight in the law of the Lord, meditating on it day and night. They are like trees planted along the riverbank, bearing fruit each season. Their leaves never wither, and they prosper in all they do. From Psalm 1

You, O Lord, are a shield around me; you are my glory, the one who holds my head high. From Psalm 3

O God who declares me innocent. Free me from my troubles. Have mercy on me and hear my prayer. ... Many people say, "Who will show us better times?"? Let your face smile on us, Lord. You have given me greater joy than those who have abundant harvests of grain and new wine. In peace I will lie down and sleep, for you alone, O Lord, will keep me safe. From Psalm 4

Let all who take refuge in you rejoice; let them sing joyful praises forever. Spread your protection over them, that all who love your name may be filled with joy. For you bless the godly, O Lord; you surround them with your shield of love. From Psalm 5

Defend the righteous. For you look deep within the mind and heart, O righteous God. God is my shield, saving those whose hearts are true and right. ... I will thank the Lord because he is just; I will sing praise to the name of the Lord Most High. From Psalm 7

The Lord is a shelter for the oppressed, a refuge in times of trouble. Those who know your name trust in you, for you, O Lord, do not abandon those who search for you. From Psalm 9

Posted by Austin at 8:41 AM
Category(s): Christian Interest

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More on the rapid launch of bull markets

This is in follow-up to Mark's post (below) regarding Ken Fisher's research on how bear markets end. In a recent Forbes article, Fisher discussed what the historical record shows with regard to how bull markets begin:

When the market rebounds, a lot of its gains will take place in a very short span (like two months or less), and people who are too cautious will miss most of these gains.

Bear markets have been typically followed by bull markets in a V-shaped pattern. The steeper and bigger the decline, the sharper and bigger the subsequent bull move. The few exceptions to this pattern in the past century have involved the emergence of completely different bad forces than the ones that created and contributed to the bear market.

For example, stocks rallied 324% from July 1932 to March 1937. After a recession-induced big bear market and partial recovery over the next 21 months, stocks encountered an entirely new kind of trouble in 1939. War in Europe sent the market down even lower than the recessionary low of early 1938.

That could happen again, with the economic equivalent of an asteroid coming out of the blue. But, absent such a surprise, we should get the normal V pattern. Its upward swing will swamp any late-stage bear market vicissitudes as they always do.

Posted by Austin at 4:48 PM
Category(s): Current Market Events

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Two-thirds, one-third rule

In September of 2007, roughly a month before the stock market peaked, Austin and I wrote an SMI cover article titled "Beating the Bear Market Blues." In it, we referred to investment advisor Ken Fisher's book The Only Three Questions That Count regarding a bear market tendency he calls the "two-thirds, one-third" rule. Here's how we summarized what Fisher writes on pages 293-294 of his book:

He explains it this way: bear markets have a tendency to experience just one-third of their total decline during the first two-thirds of their lifespan. Then during the last one-third of their duration, they cause two-thirds of their total losses. While that's a bit of an oversimplification of the historical record, it captures the general "late acceleration" idea quite well.

During my fever-induced delirium last week, I thought about this "rule" and wondered how it has held up so far in this current bear market. Of course, we can't really know for sure, because we don't know when this bear market will be over. But interestingly enough, when I started playing with the numbers this afternoon, this is what I found.

The bear market started exactly 17 months ago, using the Oct 9, 2007 peak in the S&P 500 as the beginning point. Two-thirds of the duration of this bear market would have been a little over 11 months, which would have been mid-September of last year. Interestingly enough, over the first two-thirds of the bear market (so far), the market fell 35% of the total distance it has to date.

Of course, that means that over the last one-third of the duration of this bear market, stocks have lost 65% of the total decline. In other words, if the bear market were to end today, Fisher's two-thirds, one-third rule would almost exactly describe the behavior of this bear market.

I need to emphasize that I don't feel this information proves that we're at, or near, the ultimate bear market low. I just thought it was interesting, and I was surprised it was so close to the formula when I looked up the data.

If you're looking for something useful to glean from it, I suppose it would simply be that the way this bear market has unfolded over the past 17 months hasn't been so unusual. You might even say it's been rather...predictable. Sure doesn't feel that way, yet there it is in black and white, written well before the last market peak had even been reached.

Posted by Mark at 4:01 PM
Category(s): Current Market Events

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Foreclosures concentrated in certain areas

Mark posted on this topic in January, but it bears repeating for a sense of perspective.

USA Today reports that "[m]ore than half of the nation's foreclosures last year took place in [just] 35 counties."

Those counties, spread over a dozen states, accounted for more than 1.5 million foreclosure actions last year, a USA TODAY analysis of figures compiled by the real estate listing firm RealtyTrac shows - more than were recorded in the entire United States just two years earlier....

A few of the 35 counties leading the foreclosure boom are in already-distressed areas around Detroit and Cleveland. But most are clustered in places such as Southern California, Las Vegas, Phoenix, South Florida and Washington, where home values shot up dramatically in the first half of the decade, then began to crumble....

Eight counties in Arizona, California, Florida and Nevada were the source of about a quarter of the nation's foreclosures last year.

In more than 650 other counties - about a fifth of the nation - the number of foreclosure actions actually dropped since 2006.

A USA Today map illustrates the foreclosure rate county-by-county for both 2006 and 2008.

Posted by Joseph at 3:32 PM
Category(s): Economy

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Two big risks

Sorry to be absent here this week. I've been rocked by the flu, and only today started to feel human again. But I'm guessing I'm not the only one feeling a touch of nausea this evening.

The stock market devastation of the past 17 months (particularly since last September) has reached beyond what most people ever imagined. To erase 12 years worth of gains, 56% of the value of the S&P 500, has been staggering. Worse, there's no obvious reason for the slide to stop now.

In every bear market, there are two main risks. Unfortunately, to a large degree, protecting against them is a mutually exclusive situation — you can guard against one or the other, but it's difficult to guard well against both at the same time.

The way most bear markets play out goes like this. The market falls substantially (~30% on average) over a period of 15 months or so, but it rarely does so in a straight line. Instead, the market tends to have several drops of 10-20%, with significant rallies in between. Those rallies keep hope alive as the months pass, until the pain finally becomes too great. Then, in a final selling climax, investors throw in the towel en masse and a bottom is made. Needless to say, this final selling takes place after many months of losses, but before investors have any reason to believe conditions are going to improve.

This is by far the most common bear market scenario and it brings us to our first main risk: selling near bear market bottoms. This is classic investor behavior and is largely responsible for the fact that small investors have earned roughly one-third as much as the market as a whole in recent decades (see Dalbar survey). It's completely natural, completely destructive, and it's how virtually every bear market plays out.

Because this risk is far and away the most common, yet incredibly hard to avoid despite that fact, it's the risk we at SMI have spent almost all of our effort trying to defend against. The 2000-2002 bear market was classic in this sense, and readers who were able to resist the urge to sell near the bottom looked good (at least until the past few months, but realistically even those who sold at the bottom of 2002 were likely back into the market by 2007).

The second risk is probably obvious: there's always a chance that the current bear market is going to develop into something truly devastating. Make no mistake, nearly every bear market appears to carry this potential at the time. Even the market shocks that never develop into full-blown bear markets often look as serious as a heart-attack. Consider these "end of the world" scenarios we've faced just in recent years.

• In 1997, the world faced the "Asian Contagion" which raised fears of a worldwide economic collapse.
• A year later, in 1998, the Russian debt crisis triggered the collapse of Long-Term Capital Management, a situation so serious that the Fed and big investment banks felt they had to bail them out to avoid the whole financial system potentially collapsing (hmm...sounds familiar).
• Throughout 1999, many people stockpiled basic living supplies (and pulled all their money out of the stock market) in anticipation of the Y2K crisis. It's easy to shrug off now, but at the time there were many serious and credible experts floating predictions of utter doom and ruin when the world's computers stopped functioning properly all at once.
• In 2001, 18 months into a nasty bear market and with the economy still teetering on the verge of recession, terrorists struck us here at home. Many experts went on record shortly thereafter predicting that terrorists would strike another U.S. city with some sort of biological or nuclear attack at some point over the next few years. Thankfully that hasn't happened and we pray it never will.

In each of these cases, it was completely reasonable to believe the dire warnings and expectations of doom. Yet none of those scenarios were responsible for the problems the market and economy faces today.

In truth, the really devastating bear markets and economic collapses come along so infrequently that they're extremely hard to prepare for. We had one in the 1930s obviously. Before that, you'd probably have to go back to 1873 to find anything comparable. Before that, 1837.

This is already getting long, so I'll try to wrap it up. Obviously in hindsight, we all wish we'd paid more attention to things like the bear alert indicator that would have allowed us to side-step this carnage. Unfortunately, we can't go back and undo those decisions.

So at this point, with the market down some 56%, 17 months into this bear market, the truly relevant question is this. Is today a replay of the Great Depression, 1873, or 1837? It can't be totally ruled out. And if it's true, there would potentially be some benefit in making defensive moves even at this late date.

But we also have to put today's situation into context. Many people expect some sort of replay of the 1970s as this financial crisis winds down, with lingering economic weakness and robust inflation ahead. If that were the outcome, should we be pulling money out of stocks now? Probably not with them down this far already. The 1970s weren't any fun economically, but if 1973-74 winds up being the parallel, you'd want to be invested with stocks already down 56% from their peak. (The same is true of virtually every other recession or bear market in US history, with the exception of the few mentioned above.)

It's easy to look at the current situation and see the catastrophe outcome. It's more difficult to imagine we're near the tail-end of a severe-but-not-historically-devastating bear market. Again, is today's economy about to develop into one of the worst in the past 200 years, with all that entails? In that context, it's easier to concede there's at least a decent chance that it's not.

So even here at this relatively late date, we're back to the two primary risks of bear markets. Do you protect primarily against being a seller near this potential bear market bottom? Or do you accept that risk and make changes now to protect against "the big one?"

The handful of modest steps we've suggested lately — making small changes to your stock/bond allocation, using SMIVX for some (perhaps more) of your Upgrading money — these are ways to hedge a little against the big one, without being undone by the more common risk that this won't turn into an utter disaster of Great Depression proportions.

We don't know how this will play out. I wish we could tell you, I really do. All we can do is outline the risks as we see them and let you decide what to do with that information. I will say that Austin and I are not selling here. We're not raging bulls here either. We just don't see the risk/reward benefit — at this late date and with the losses we've already absorbed — favoring being a seller here.

Posted by Mark at 8:12 AM
Category(s): Investing Principles

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"Is there any such thing as Christians cheering each other up?" (Philippians 2:1, LB)

It's not going to be easy, I know. But I hope this month's cover article reminded you of God's great and precious promises and got your eyes looking up.

On the financial front down here, I searched everywhere for a positive article. (That there are so few to be found should be of interest to contrarians everywhere.) But here are two that I hope will provide at least a little encouragement.

• Done With Bad News, Here Are Four Reasons To Be Optimistic

  In the face of a nearly daily barrage of bad news, new lows and low spirits, perhaps it is important to smash the news cycle and find a few reasons to be more upbeat regarding the economy and markets. With that in mind, here are four reasons to be long-term optimistic: (More...)

• 7 Signs of an Economic Bottom

  Recent news on continued home price deflation and sales, Bernanke's testimony that the economy could be worse than expected and record low consumer confidence all mean the economy is still shrinking. The economy is, however, starting to show signs of shrinking at a slowing rate, which is the beginning of the bottoming process. The early signs of finding a bottom include: (More...)
  

Posted by Austin at 3:44 PM
Category(s): Economy

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Sector Rotation update

By mid-February, our current SR recommendation looked like it was heading for the exit. Then came the roughly 12% slide in the S&P 500 over the last two weeks.

As I noted last month, our recommended SR fund started 2009 with over half of its assets in cash. Normally, we wouldn't particularly care for a fund like that, but it has obviously helped limit our losses in this downturn. Its 6-month losses are less than half that of most of the other SR funds in the database (we've owned the fund for 5 months now).

That defensive posture paid off again over the past two weeks, shooting the fund back up to the #2 spot in the month-end SR rankings. So we'll be holding onto it for March.

Posted by Mark at 10:05 AM
Category(s): SMI Advanced Strategies

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