Top 3 Real Estate Myths for Home Sellers

Guest Post: Tre Pryor, oldest of Sound Mind Investing Editor Austin Pryor's three sons, is a Realtor® residing in Louisville, Kentucky. He is also the Editor-in-Chief of the LouisvilleHomesBlog.com where visitors can get targeted real estate news and advice for home buyers and sellers in the Louisville area.

Because there is so much information concerning the housing market flooding our lives these days, it's more important than ever to distinguish the truth from the myth. Whether myths about foreclosures or myths about home improvement, you should be informed—or team up with an a Realtor who is.

Myth #1: Sellers should price their home higher than market value to allow for negotiation room.

When the market eventually tilts toward the seller's advantage, this would be good advice. But in today's buyers market, there is a huge selection of homes and competition is fierce for each buyer's attention.

Today's buyer looks at an average of 12-18 homes before writing an offer. If a home seller prices his house above market value, that home may not "make the cut" to be one of those dozen or so homes that a buyer will visit in person. The longer a home is on the market, the greater the perception that the home is unwanted or undesirable. The thought process is, "Don't the best homes sell fast?"

Best Strategy: Get a solid Competitive Market Analysis (CMA) from your Realtor and price your home at market value. New listings have the most showings during the first 60 days. After that, traffic drops off considerably.

Myth #2: Selling a home For Sale By Owner (FSBO) makes the homeowner the most money.

There's a reason why Realtors are more valued than ever. The market grew tougher and the number of homes sold by their owners dropped to the lowest level in years—just 9%. Only eight years ago, 14% of all homes sold were FSBOs. (This includes transactions involving parties that knew each other, such as a parent selling a home to a child.)

Selling via this method is extremely difficult. In today's real estate market, expertise is needed to best evaluate, price, and promote a home to get it sold. It's also important to remember that if the homeowner doesn't have a firm grasp on the true value of their home, they could accidentally underprice the property and lose money.

Lastly, most buyers understand what FSBO sellers are trying to do ... save money. So when writing an offer on a FSBO property, home buyers are more likely to "low ball" and try to take a share of that unpaid commission for themselves.

Best Strategy: Find an experienced Realtor. Ask trusted friends/family for referrals and search online for top agents.

Myth #3: Don't update the home, just drop the asking price.

Remember when I said it was a tough market for home sellers? Yes, it's still true. The goal for every online listing, virtual tour, or property profile is to get a buyer in the home. But they won't come if the home doesn't look appealing in the photos.

For example, replacing some old, dingy carpeting with brand new flooring does a couple of things. First, it removes a big negative and possible hindrance to a showing. Second, the update is now something that can be promoted, which encourages a possible visit. It's a win-win!

The classic real estate saying that what sold a home was, "Location, location, location!" In today's real estate market, it's more likely to be "Condition, condition, condition!"

Best Strategy: Ask a trusted realtor which updates will give your home the best bang for the buck. Example, replacing your front door continues to rank the highest return on investment for home improvements.

Posted by Matthew at 2:14 PM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): home sellers, mortgage, real estate myths

Email this post

How unique has this market been? Pretty unique.

Based on the title of this post, you're probably thinking I'm going to talk about this year's market, or maybe the market over the past three years since the financial crisis. Wrong.

I'm talking about the market over the past 30 years (through Sept 30).

And really, it's two markets in combination that have produced such a unique outcome. The stock market has played a role, but really it's been a once-in-a-lifetime bond market that's driven the unique circumstances.

From Bloomberg:

The biggest bond gains in almost a decade have pushed returns on Treasuries above stocks over the past 30 years, the first time that’s happened since before the Civil War.

Long-term government bonds have gained 11.5 percent a year on average over the past three decades, beating the 10.8 percent increase in the S&P 500, said Jim Bianco, president of Bianco Research in Chicago.

Amazing, particularly in light of how awesome the 1982-1999 stock market run appeared at the time. Of course, nobody knew stocks would stall for the next 12 years while the bond rally would continue to boom.

So what are the chances this could happen again? Pretty slim. As Bill Gross says:

“The rally in bonds is a once in a millennium event, but it’s absolutely mathematically impossible for bonds to get any kind of returns like this going forward whereas stock returns can repeat themselves, and are likely to outperform,” he said. “If you missed the rally in bonds, well, then that’s it.”

And that makes sense. Long-term bonds were able to eek out a victory over stocks based on the fact that interest rates fell from the mid-teens to low single digits during this period. Given that bond values rise as interest rates fall, that produced huge gains for bonds. But it's mathematically impossible to repeat unless bond yields were to once again start at very high levels.

Inflation History: The Rise and Fall of the U.S. Dollar

Posted by Mark at 9:21 AM | Comments (2) | TrackBack
Category(s): Current Market Events
Tag(s): bonds, interest rates, market history

Email this post

Share |

Occupy Wall Street: Good, bad, or indifferent

A lot has been said of the Occupy Wall Street (OWS) movement, both for and against it. In case you have somehow managed to avoid hearing about it, here's Wikipedia's definition:

... is an ongoing series of demonstrations in New York City based in Zuccotti Park in the Wall Street financial district. The protests were initiated by the Canadian activist group Adbusters. They are mainly protesting social and economic inequality, corporate greed, corruption and influence over government—particularly from the financial services sector—and lobbyists. The protesters' slogan, "We are the 99%", refers to the difference in wealth in the U.S. between the wealthiest 1% and the rest of the population.

Some are praising it.

Others, like Ben Stein, not so much. In Letters to the Lazy, he wrote:

But don't just whine and beat drums about people you don't know and don't mock the best political and economic system there has ever been. Do something specific and constructive, and if you are willing to work as hard as the people on Wall Street, you might just accomplish something.

But what about the rest of you, those not in the media and not in the movement. What do you think of it? Is it helpful and productive? Does it at least stimulate conversation? Or maybe it's a pointless act in futility? Sound off below!

Posted by Matthew at 2:26 PM | Comments (10) | TrackBack
Category(s): Current Market Events, Economy
Tag(s): economy, Occupy Wall Street, OWS

Email this post

What would we do without the financial experts?

Tired of reading about Greece, Italy, and the problems in Europe? Sorry, that story isn't going away any time soon. But here's a word of encouragement from one Zachary Karabell. His bio says he's president of River Twice Capital, a regular commentator on CNBC, and the coauthor of Superfusion: How China and America Became One Economy and Why the World's Prosperity Depends on It. Sounds like an informed guy. In a recent article, he explains Why Europe Won't Implode:

The assumption in finance land is that Greece will default on its debts, and that will then trigger a financial crisis to rival, if not surpass, what happened three years ago. Mavens such as George Soros have predicted as much. But while the risk is undeniable, it is just that—a risk. It would be foolish to ignore, but as the panic spreads, it is increasingly clear that it is just as foolish to assume that all this is a done deal and that incalculable pain lies ahead. Contrary to what many are now predicting, Europe—reeling though it is—will not implode....

The risk remains that globally, because of Europe, we are on a precipice and will fall. That needs to be factored into any near-term decision about money, business, and economic outlook. But the costs of dissolution are prohibitive, for Europe and for the world. China, Brazil, India, the new creditor nations of the world, have begun the unthinkable conversation about bailing out Europe if Europe will not bail out itself: an unlikely event but indicative of how serious this is. In the end, it is those costs for Germany, for France, and for the entire euro zone that should act as a bulwark against the worst-case scenario.

Naturally, there are those who differ. Here's a contrary opinion offered by Matthew Lynn, chief executive of Strategy Economics, a London-based consultancy and author of Bust: Greece, The Euro and The Sovereign Debt Crisis. Another expert we can call on to settle the matter. Unfortunately, his view (and, it seems, the majority view) is not as sunny as that of Mr. Karabell:

The imminent Greek default is now the only issue that matters to the financial markets. The country is running out of money to pay its bills. It can no longer borrow on the markets. It has missed the deficit-reduction targets in the bailout package, and unless the euro area’s political leaders can come up with a fresh rescue package it will soon have no choice but to renege on it debts.

The only force that can avert catastrophe is that strange double-headed beast known to bond traders as Markozy — the French President Nicolas Sarkozy and the German Chancellor Angela Merkel. Neither shows any signs of getting to grips with the scale of the challenge they face, nor have they done so at any point since this drama started 18 months ago.... Europe is stuck with two incompetent leaders [who] have neither the authority nor the imagination to cope with the scale of the challenge they face.... In reality, the Greek default is going to be ugly.

So, as always, the experts are of little help when it comes to predicting future outcomes. You can't go "all in" or "all out" based on their conflicting opinions (which, in any event, may well change tomorrow). That's why we continually counsel maintaining a steady course and following inside-out thinking when it comes to your investments. As we consistently remind our readers, you want to be a proactive, not a reactive, investor.

Inflation History: The Rise and Fall of the U.S. Dollar

Posted by Austin at 1:31 PM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): current market events, debt crisis, financial experts

Email this post

Share |

10 market rules to remember

Bob Farrell was a legendary analyst for Merrill Lynch from 1967-1992. As this MarketWatch article summarized, "Over several decades at brokerage giant Merrill Lynch & Co., Farrell had a front-row seat to the go-go markets of the late 1960s, mid-1980s and late 1990s, the brutal bear market of 1973-74, and October 1987's crash. Out of those and other experiences came Farrell's 10 "Market Rules to Remember."

Here they are:

1. Markets tend to return to the mean over time
2. Excesses in one direction will lead to an opposite excess in the other direction
3. There are no new eras — excesses are never permanent
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
5. The public buys the most at the top and the least at the bottom
6. Fear and greed are stronger than long-term resolve
7. Markets are strongest when the are broad and weakest when the narrow to a handful of blue chip names
8. Bear markets have three stages — i) sharp down, ii) reflexive rebound, iii) a drawn-out fundamental downtrend
9. When all the experts agree, something else is going to happen
10. Bull markets are more fun than bear markets

Inflation History: The Rise and Fall of the U.S. Dollar

Posted by Mark at 10:33 AM | Comments (0) | TrackBack
Category(s): Current Market Events, Investing Principles
Tag(s): christian investing, current market events, investing, investing principles

Email this post

Share |

When the storm comes, you have to hold on even tighter

As far as I know, the Apostle Paul never lived through a frightening economic storm. How else to account for his being so upbeat:

Rejoice in the Lord always. I will say it again: Rejoice! Do not be anxious about anything (emphasis added)...

But then we learn his secret:

... but in every situation, by prayer and petition, with thanksgiving, present your requests to God. And the peace of God, which transcends all understanding, will guard your hearts and your minds in Christ Jesus....I have learned to be content whatever the circumstances. I know what it is to be in need, and I know what it is to have plenty. I have learned the secret of being content in any and every situation, whether well fed or hungry, whether living in plenty or in want. I can do all this through him who gives me strength (Philippians 4:4-13).

Thought this reminder might be helpful after recent market turbulence.

This week, perhaps it would give you a more hopeful perspective to reflect on God's promises of provision (Matthew 6:25-34) and ask the Lord what attitude, in light of His promises, He wants you to adopt. And then do it "through him who gives ... strength."

And for those who'd like a little encouragement of the non-spiritual kind, you might find it hopeful that "one of Wall Street’s most eminent analysts is forecasting an 18% return for the stock market over the next six months."

Inflation History: The Rise and Fall of the U.S. Dollar

Posted by Austin at 2:57 PM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): faith, fear, market uncertainty, stewardship

Email this post

Share |

SMI's Mark Biller talks gold with Howard Dayton

SMI's executive editor Mark Biller is the guest today on MoneyWise, the nationally syndicated radio program hosted by Howard Dayton and Steve Moore. The subject: gold.

As a reminder, MoneyWise, which debuted in March, is produced by Compass — finances God's way, a ministry Howard launched in 2009 after leaving Crown Financial Ministries. The program is heard on more than 400 stations and outlets.

The timing of this radio program coincides nicely with our recently released 21-page FREE report: Gold as an Investment: Will Precious Metals Continue To Shine? Get your free copy today!

Use the audio players below to listen (click the arrow for the program you want to hear).

Inflation History: The Rise and Fall of the U.S. Dollar

Posted by Mark at 1:51 PM | Comments (0) | TrackBack
Category(s): Current Market Events, Inflation Watch, SMI General Announcements
Tag(s): gold, inflation, Moneywise, radio

Email this post

Share |

Are these unprecedented times? Not really.

While it seems like things have never been the way they are right now, this excerpt from Ron Blue's 1994 book Storm Shelter reminds us that "What has been will be again, what has been done will be done again; there is nothing new under the sun" (Ecc 1:9). Ron points out that while economic uncertainty is certain, God's principles are adequate for our protection. They've been tested through the centuries and never found wanting.

The picture is as clear in my mind as it was nearly thirteen years ago. As I pulled off the interstate en route to my office, I did not see the road markers; instead my eyes swam with the signs of the times.

The year was 1982. Interest and inflation rates had soared to all-time highs, investors faced crushing 70 percent tax brackets, and the price of gold leapfrogged daily. Taking stock of the situation, most analysts warned of a devastating financial explosion within the next few years.

As I drove to work that day, the economic consequences seemed both crippling and inevitable. I had just launched our investment and financial counseling firm. How, I wondered, were we supposed to respond to the clients who came to us for advice? Could anyone afford to purchase a home with 15 to 20 percent interest rates? Which kinds of investments and tax plans could stand up to double-digit inflation? And if the predicted monetary collapse did occur, would the resulting political turmoil uproot even the best-laid financial plans?

One of my fears as I navigated the interstate highway that day was that we faced a "worst-ever"? economic climate. Yet economic uncertainty - and its accompanying effects on our sense of security and well-being - are nothing new.

Ten years earlier, in 1972, we had been saddled with Watergate and an oil crisis that threatened to throttle the world's economy. Who can forget the lines at the gas stations or the rationing of fuel oil that winter? Then, too, I remember being hit with wage and price controls for the first time since World War II. And for the first time in my memory, the prime rate hit ten percent. Economic security seemed an elusive, if not impossible, dream.

Ten years before that, in 1962, the specter of economic and political uncertainty had hovered in every corner of the world. Our amazement at seeing a shoe-pounding Nikita Khrushchev vow to "bury"? us turned to horror as the Cuban missile crisis unfolded. At that point a nuclear holocaust seemed at least possible, if not imminent. And Vietnam lay just around the corner . . .

In 1952, in the shadow of the spread of Communism, amid the mud and blood of the Korean War, bomb shelters were among the best-selling items in the United States. In 1942, we faced Pearl Harbor and felt the full force of our entry into World War II. In 1932 we awoke to the nightmare of the Great Depression. And on and on and on. The point is that we will always face uncertainty.

Suddenly, I felt the subconscious click of the proverbial light bulb: The biblical principles of money management I had been teaching and using for years would work under any economic scenario. Armed with these concepts, I knew exactly how to help our clients weather the coming storm, no matter how hard the financial winds blew.

The predicted financial blowout never did occur. Yet as our business grew in the years that followed, we faced a thousand different financial situations that seemed specially tailored to test the worth and endurance of the money-management concepts our firm espoused. But in each and every case the biblical principles held fast, strengthening our clients' economic positions - and bringing them peace and security in the bargain.

So what does this mean? It means you should have inside-out thinking. You should avoid panic selling. You should have a long-term game plan and stick to it.

You see, it's easy to make a case that this time is different. But friends, just as you should not "grieve like the rest of men, who have no hope" (1 Thess. 4:13), neither should you be fearful like the rest of men who have no heavenly Father who has promised to "meet all your needs according to his glorious riches in Christ Jesus" (Phil. 4:19). So, keep praying, that the Father "may give you the Spirit of wisdom and revelation, so that you may know Him better" (Eph.1:17).

Inflation History: The Rise and Fall of the U.S. Dollar

Posted by Matthew at 10:37 AM | Comments (2) | TrackBack
Category(s): Current Market Events, Economy
Tag(s): economy, Faith, market volatility

Email this post

Share |

Perspective: Avoid panic selling in a volatile market

[Originally posted on our Member's Blog on 08/05/2011]

How did you hold up yesterday? Yesterday was a good example of panic selling. Don Hays offered this morning that the volume of declining stocks was 82 times that of advancing stocks on the Nasdaq index yesterday. That's extreme. So if you weathered yesterday pretty well emotionally, it's a good sign.

I think the reason people are so fearful right now is because things feel so out of control. Government seems to be making lots of decisions, but few of them seem like really good ones. We keep hearing that the economy is broken (though we're a long way from bread lines and shanty towns). We've been burned by the stock market twice in the past decade and people are worried that we're out of bullets to deal with another crisis. Things just feel unstable.

Maybe you feel this way. If so, I'm not going to tell you that everything is fine and you don't need to be concerned. Nobody knows what the future holds. It is possible financial panic is around the corner. As much as we'd like to, it's almost impossible to ever completely rule that out.

But before making the leap of (negative) faith (also known as worry) to that conclusion, let's ponder a less dramatic scenario.

Since 1928, there have been 26 bull markets, including the one we're currently/recently in. As this post from seekingalpha.com stated on April 26, just a few days before the market peaked, this current/recent bull was very close to the middle of the pack in terms of both length and total gains. A little over two years and right around a 100% gain. Very normal.

All of that is fine, but if the bull market length and duration we just experienced was normal, it stands to reason that hitting a bear market after that point would also be quite normal, right?

This isn't an argument to say we have flipped over and this will develop into a bear market. I don't know if that's the case at this point or not, and neither does anyone else.

Rather, the point I'm trying to make today is that even if this is the beginning of a new bear market, it doesn't necessarily mean this bear market is going to be catastrophic or historic. It could just be a "run of the mill" bear, in the same way that the last bull was fairly "normal".

And it could be that it's happening not because the world is about to end, but because this is what the market does. It cycles between bull markets and bear markets. I hope you understand that if you're going to be an investor over the span of multiple decades, you're going to have to weather a number of bear markets. Some will be longer and deeper than others. But they're going to happen.

You know what else? They're normal. That should be some comfort. You don't need to worry about them or freak out when they finally do arrive. Sure they're unpleasant, but so is getting your teeth cleaned at the dentist. You still do it (I hope). They're basically the equivalent of investing winter, and they come around just like the seasons.

A lot of today's investors came of age during the extended bull market of 1982-1999. That bull market was by far the exception to the rule. (And in fairness, even that bull market technically had a mini-bear in there. Remember 1987? The worst single day for the stock market ever when it plunged nearly 23% in a single day. Makes yesterday look like a picnic.)

Hopefully it's some comfort to take a deep breath and recognize that a bear market every 3-4 years is about the historical average. It depends on how you slice and dice the data, but that's more or less been the average over the past century. If this is a new bear, which I'm not quite ready to concede, it will be our third in twelve years. Hmm. Dare we say, not all that abnormal? That the first two were a bit more severe than average shouldn't be a huge shock, given the massive bull market that preceded them, and the fact that the last one coincided with a banking crisis, which is unusual and not in a good way.

As you go about your weekend, try not to worry about the market. Life is more than the food we eat and the clothes we wear, and our Father knows our needs and promises to meet them. (That may sound familiar, I didn't come up with it myself.) It could be that next week will be wild and nasty. But it might not be. It could also be that this is a correction that doesn't ever develop into a bear market, in which case you'll forget about this little blip faster than you can imagine. After all, how often do you think about last summer's correction? It was worse than this year's has been so far.

As always, we encourage you to stick with your long-term investing plan. Hopefully you followed our advice and developed one long ago at a time when your emotions weren't screaming at you. Trust that version of yourself — I can almost guarantee he/she is a better information processor and decision-maker than the version that's feeling panicky today.

[For more about a membership to Sound Mind Investing, click here]

Inflation History: The Rise and Fall of the U.S. Dollar

Posted by Matthew at 2:15 PM | Comments (0) | TrackBack
Category(s): Current Market Events, Economy
Tag(s): economy, market volatility

Email this post

Share |

SMI audio commentary: Face your fears

Does the market's recent weakness have you a little weak in the knees? SMI founder and publisher Austin Pryor says keeping historical trends in mind can help you face your fears.

To listen to his audio commentary, click the arrow (1:35).

Inflation History: The Rise and Fall of the U.S. Dollar

Posted by Matthew at 2:05 PM | Comments (0) | TrackBack
Category(s): Current Market Events, Economy
Tag(s): audio, current market events, economy

Email this post

Share |

The debt-ceiling deal and your investments

The debt deal is finally a done deal. Despite the breathless reporting of recent weeks, the outcome was never likely to be a big deal for long-term investors.

Why? Our (now) former assistant editor Joseph Slife talked about that in a conversation yesterday with host Bob Crittenden on The Meeting House from Alabama's Faith Radio.

Click the arrow to listen (19 minutes).

In case you missed our earlier announcement, Joseph has left SMI after four years to go full time into radio, producing WORLD magazine's new weekly radio program, The World and Everything In It.

However, he'll still be writing for us on an occasional basis.

Inflation History: The Rise and Fall of the U.S. Dollar

Posted by Matthew at 11:43 AM | Comments (1) | TrackBack
Category(s): Current Market Events, SMI General Announcements
Tag(s): debt-ceiling deal, Inside-out investing, radio

Email this post

Share |

Two sides to every market

One of the least appreciated keys to becoming a successful investor is resigning yourself to operating under uncertain circumstances.

This may seem an odd statement. Some new investors assume that during bull markets the investing landscape looks good so investors buy stocks, whereas during bear markets the bad news is obvious so investors sell stocks. If only it were so simple.

Getty Images via @daylife

The reality is there are always two sides to every market. Markets are made up of buyers and sellers interacting — every trade requires a buyer and seller. Naturally there are all types of buyers and sellers (people buying and selling for various reasons), but at essence, most of the trades that will be made today — and every other day — will be made between one party that believes the current price is a good one to sell at and another party that believes the exact same price represents a good buying opportunity.

This is the main reason why Sound Mind Investing spends so little effort trying to forecast what the market will do next. There are always two (or more!) compelling arguments regarding the most likely future path for the market. Equally brilliant experts line up on either side of the debate, half arguing the market will go up for one set of reasons, the other half arguing it will decline for a different set of reasons.

I bring this up today because it occurs to me that the negative (seller's) side of the market equation seems to be getting most of the headlines lately, and I suspect many investors aren't even aware of the primary positive (buyer's) argument.

The negatives at present are numerous and well known:

1. Massive financial problems in Europe threaten to unleash another act in the unfolding world credit drama;
2. The U.S. can't seem to come to any sort of solution regarding its own debt problem — with the seemingly important deadline of Aug. 2 for raising the national debt ceiling looming;
3. The Federal Reserve's "QE2" program officially ended on June 30, leaving significant questions as to what happens to our economy without this significant stimulus (not to mention if there will be adequate demand for our Treasury debt without the Fed as a buyer, and the impact that may have on interest rates);
4. The economy seems to be weakening, as was vividly demonstrated in last week's dismal jobs report.

What is the counterbalance to all this bad news? Or put differently, in light of all these negatives, what positive has been responsible for limiting losses in stocks this year to the roughly 7% decline in May-June?

The answer: Company profits have been strong. And not just a little strong. Really strong.

Starting in 2007, S&P 500 profits fell for nine consecutive quarters, with annual profits bottoming out at $60.59 per share in 2008. According to the article, earnings are forecast to reach $99.34 this year — a remarkable turnaround, even if the estimate does prove to be a bit high.

As a result of this tremendous earnings growth, the closely-watched P/E (price/earnings) ratio for the S&P 500 is actually still bouncing around the same level it was when the market was bottoming out in March 2009. That is quite unusual — P/E ratios typically expand during market-doubling bull markets. This leads many bulls to believe there is still plenty of room for stock prices to move higher.

Whether or not that's true is a discussion for another day. Just keep in mind that in the long-term, stock prices are tied to corporate earnings. So it makes sense that prices would rise as these earnings have rebounded.

Posted by Mark at 11:25 AM | Comments (0) | TrackBack
Category(s): Current Market Events, Investing Principles
Tag(s): bulls and bears, earnings

Email this post

From first to worst

Bloomberg notes that three fund managers who used be at the top of their game are struggling mightily.

Bruce Berkowitz, Kenneth Heebner and Bill Miller, three of the best-known U.S. stock pickers, are competing for last place this year after their bets on an economic expansion backfired.

Funds run by Berkowitz of Fairholme Capital Management LLC, Heebner of Capital Growth Management LP and Miller of Legg Mason Inc. are the three worst performers among large diversified U.S. mutual funds in 2011, according to data from Chicago-based Morningstar Inc. The funds lost 11 percent to 12 percent through June 9, compared with a gain of 3.4 percent for the Standard & Poor's 500 Index.

Here is what reporters call the "money quote":

"People assume because certain managers have had good streaks that they are always going to be a step ahead of the market," Russel Kinnel, director of mutual fund research at Morningstar, said in a telephone interview. "It never works out that way."

Indeed. As much as we may wish that a winning fund will always be a winner, that's just not the way it is. This is why SMI offers a Fund Upgrading approach that identifies and recommends the funds — in various risk categories — that are the best performers at any given time. We care little that a fund was a top performer three years ago, or even last year. We want to know what it is doing now.

We've held funds managed by the above-mentioned managers in the past. All three of these guys are smart and capable, and we hope they'll have future success. But we're not going to hold the funds they manage unless those funds are currently outperforming others in their peer group. That's why Upgrading has strongly outperformed the market over time.

All mutual funds — even the most successful over the long haul — go through periods of adversity. When they do, we move on, because that is in the best interest of those using our Upgrading strategy.

Not yet an SMI subscriber or web member? Learn more about SMI and sign up today!

Posted by Joseph at 10:55 AM | Comments (0) | TrackBack
Category(s): Current Market Events, SMI Model Portfolios
Tag(s): fund performance, Upgrading

Email this post

TIPS update

At a big investing conference last week in Chicago, PIMCO chief Bill Gross made a compelling case that Treasury yields have fallen so low that it's difficult to see how they'll earn much for investors over the next few years — especially if inflation levels that many expect come to fruition. (PIMCO runs the world's largest bond fund, PIMCO Total Return.)

Gross's comments brought to mind an article I'd read a month ago, but hadn't commented on. Provocatively titled, Holding TIPS Will Make You Poorer, author Brett Arends painted an extremely grim outlook for short-term TIPS bonds.

First, a quick refresher for those who aren't clear on exactly what TIPS (Treasury Inflation-Protected Securities) are or how they work.

TIPS are inflation-protected versions of U.S. treasury bonds. They pay a lower yield than a regular Treasury bond of the same length, but also pay the owner the official rate of inflation during that time.

So, for example, if a 10-year Treasury was yielding 3.0%, a 10-year TIPS bond might yield around 1.2% at a time when official CPI inflation was running 1.6%. That TIPS owner would expect to earn the 1.2% base yield plus the 1.6% inflation yield, for a total of 2.8%. The relationships are never exactly precise, which reflects the bond market's fear (or lack thereof) of future inflation at the moment.

Back to Arends' column. His point was that with real (after-inflation) yields on short-term TIPS having gone negative (investors would earn the inflation rate minus a small amount), these short-term TIPS were almost sure to be losers going forward.

Ironically, after pulling that article up last week in order to comment on it, I came across a new column by the same author. This column's subtitle is Some TIPS Bonds May Still Offer a Decent Deal. Now this may seem double-minded and unstable in all his ways, but it's really not. (Arends is actually one of my favorite columnists because he consistently makes interesting and well-reasoned points.)

The summary of this latest column is that while short-term TIPS look like a bad deal due to their incredibly low interest rates (especially if rates are set to rise, as Gross contends), longer-term TIPS don't look so bad. In fact, when you factor in that they protect against inflation on the one hand, and deflation on the other (via the Treasury promising to pay back at least their face value at maturity), they hold some particular appeal at a moment in time when inflation still seems like a distinct possibility, yet softening economic indicators have reawakened deflationary fears that another recession could be looming.

It's worth noting that both of Arends' columns seem to assume that investors will buy and hold individual TIPS bonds until maturity. That's not likely the case with most SMI readers, who are more likely to own TIPS through a mutual fund. The Gross/Arends arguments also seem to assume an investment time frame of at least the next several years. They are primarily arguing that buyers of these bonds today are going to get hurt as they hold them over the next several years.

It's worth noting that while people have been negative on Treasuries for quite a while, Treasuries have continued to defy expectations and rally this year. So have TIPS. In fact, while many would have said at the beginning of the year that Treasuries/TIPS have nowhere to go but down, a Vanguard fund focused on TIPS is already up 5.02% year-to-date. That's a healthy full-year return earned in less than half a year. Now it's entirely possible that entire gain could evaporate over the next six months — we certainly don't know what the future holds. The point is simply that the length of the current Treasury rally has already surprised most experts, making it difficult to predict how long it may last.

In summary, TIPS still have some appeal. But given their current valuations and today's extremely low interest rates, along other external factors (debt-ceiling impasse, end of the Fed's QE2 policy), that appeal appears to be significantly lower than usual.

Posted by Mark at 2:20 PM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): bonds, inflation, TIPS

Email this post

401(k) loans and 2nd mortgages

Shocking: almost 30% of 401(k) savers have a 401(k) loan outstanding.

I'm speculating here, but I suspect the type of faulty analysis presented in this article is one reason that might be the case:

RambergMediaImages via Flickr

What is more, with interest rates so low and the stock market volatile, a 401(k) loan can offer a decent rate of return. An investor who took a $25,000 loan five years ago at 6% interest would have paid himself about $4,000 in interest about the same return as if he had invested in a Standard & Poor's 500 stock index fund for the same period, without the crash-induced stress.

For borrowers who use the money to pay off high-interest debt, the effective return can be greater, thanks to the savings they get by replacing it with the lower-interest loan.

Wrong. Sure, the balance in the 401(k) might be the same whether the $4,000 in interest came from the borrower's checking account vs. appreciation in the stock market. But their overall financial condition isn't the same.

In the case of the non-loan, their checking account is untouched, plus they've gained $4,000 in appreciation within their 401(k). In contrast, with the 401(k) loan, their 401(k) balance is the same, but their checking account is $4,000 lower due to the interest they've had to pay into their 401(k) plan. So in total they are $4,000 poorer!

Naturally, they got the $4,000 loan in the first place, which theoretically offsets the $4,000 hole in their checking account. But in too many cases, that money is spent on stuff the person wouldn't otherwise borrow for if they realized that borrowing from their 401(k) really isn't much different than borrowing the money from the bank. Too often, articles like this one make it seem like 401(k) loans offer something for nothing. Not so.

The idea that borrowing from yourself is somehow free is an illusion. As we pointed out in early 2009, borrowing from a 401(k) might be a reasonable idea if you are absolutely going to have to borrow anyway. Otherwise, it's usually a bad idea.

Related: those with 2nd mortgages are more than twice as likely to owe more than their house is worth than those without 2nd mortgages (38% vs. 18%).

What do these items have in common? Both 401(k) plans and home equity used to be regarded by most people as more or less "untouchable" savings. Somewhere along the line that changed and many people started using these reserves to supplement income. That has proven to be a big mistake.

Posted by Mark at 11:50 AM | Comments (0) | TrackBack
Category(s): Current Market Events, Retirement
Tag(s): 401(k) loan, borrowing from a 401(k)

Email this post

What's going on in the economy?

SMI's executive editor Mark Biller offered an easy-to-understand overview of current economic conditions on Friday's "Connecting Faith" program on Faith Radio (with stations in Minnesota, Iowa, Wisconsin, and the Dakotas).

Mark also talked with guest host Michelle Strombeck about how implementing wise investing boundaries can help investors gain financial stability and make steady long-term progress.

To listen, click the arrow on the audio player below.

Posted by Joseph at 3:35 PM | Comments (1) | TrackBack
Category(s): Current Market Events, Economy
Tag(s): economy, radio

Email this post

Small-cap primer

Mark Jewell, the personal finance for the Associated Press, takes note of a milestone that didn't get much attention amid last week's other important news: The Russell 2000 index of small cap stocks hit an all-time high.

[The Russell index is] up nearly 143 percent from its low in March 2009, when stocks hit bottom during the financial meltdown. By comparison the Standard & Poor's 500 is up 99 percent....

Here are answers to common questions about the Russell 2000, why it's climbed so high, and whether the small-cap surge still has momentum:

Q: What stocks are in the Russell 2000?

A: The Russell 2000 includes 2,000 of the smallest stocks, based on their market capitalization. Small-cap stocks are typically defined as companies with a market value of $300 million to $2 billion....

That value of the Russell 2000 represents 8 percent of the total stock market. By comparison, the S&P 500 represents about 75 percent, which is why those stocks anchor 401(k) and other retirement accounts....

Q: Why has the Russell 2000 climbed so high?

A: Small-cap stocks tend to be among the first to rise when the economy rebounds. That's because these companies are more nimble operationally, and generally invest in their growth as a recovery gains momentum.... Small-cap stocks have also benefited from low interest rates. Smaller companies are more likely to rely on borrowing, and low rates can really help a bottom line.

Q: How long have small-cap stocks been outperforming large-cap stocks?

A: Small-cap stocks have outperformed large-caps for most of the last 11 years. Their current dominance outlasts a 9-year small-cap run that started in 1974....

Q: Can small-caps keep this up?

A: Many market pros say the small-cap advantage is about to end. They argue small-cap stocks have risen so high that they're unjustifiably expensive, considering the profits they're expected to generate....

Q: Why might the small-cap rally still have legs?

A: Small-caps could increasingly become buyout targets of bigger companies looking to dip into cash hoards that have grown to record levels. S&P 500 companies have $940 billion on hand, with nearly one-third of that stash accumulated since late 2008. Expect stocks of acquisition targets to surge when deals happen.

Meanwhile, Morningstar reports that several well-known small-cap funds have closed (or are closing) to new investors. (Funds typically close because more money is coming in than the manager thinks he or she can invest wisely.)

American Beacon Small Cap Value and Heartland Value Plus will soon close to new investors.

Their closures follow the shuttering of a number of other small-cap funds in recent weeks and coincide with more than two years of strong performance and rising valuation levels for the Russell 2000 Index and other small-cap benchmarks....

Royce Micro-Cap and Royce Premier also said they will remain open only to existing investors and certain preapproved relationships.

SMI's investing strategies help you stay broadly diversified across the market, so you can gain from strongly performing categories (such as the current performance in small caps) without taking the high level of risk that comes from being overly concentrated in any one area.

To learn more about SMI, check out our limited-time free membership offer!

Posted by Joseph at 9:25 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): small-cap, stock market, stocks

Email this post

A return to the gold standard? Not likely

In this month's cover article (subscribers' link) in the SMI newsletter, I listed several of the arguments made by the gold bulls. One was the suggestion that the U.S. might some day return to a gold standard. It's assumed to be the only way guaranteed to rein in out-of-control federal spending and defeat inflation once and for all.

I indicated that of all the bullish arguments, this seemed the weakest. It relied on the Congress and president to conspire to limit their own spending ambitions. This seems to me an obvious non-starter.

Here's the relevant excerpt:

In recent decades, rare has been the monetary heavyweight who would openly suggest a return to a form of gold standard. Following the various financial and currency crises of the past three years, that's no longer the case. Last year, the president of the World Bank called for a return to a fixed rate exchange system (the former one broke down in 1971), adding, "The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values."...

Gold bugs have seized on the possibility of a new gold standard and made the calculations to determine what gold's price would need to be in order for the dollar to once again be backed by gold. One approach to doing this is to compare the amount of dollars in the Fed's monetary base ($1,700 billion) with the amount of gold the U.S. currently owns (263 million ounces). The answer pegs the required price of gold at about $6,400 ounce, 350% above current levels.

The problem with this particular bullish argument is that a gold standard restricts a government's freedom to print money to pay for every whim. A return to one, even in partial form, seems only remotely plausible, if not unthinkable.

Here's a similar skeptical response, except in this writer's view the "blame" for the unlikelihood of a successful return to a form of gold standard lies not with the political class but the American people:

The voting booth would quickly crush any attempt to bring back what the masses do not understand, and the American people have little understanding of what money is.

In addition, and despite another old proverb that tells us "we have gold, because we cannot trust governments," your average American, especially her elite, harbors an extreme trust of government. It can solve all problems in their view, it can even tame "climate change" if only given a chance, and something as fundamental as the provision of money cannot, and should not, be left to anything as independent of political manipulation like adhering to a gold standard requires. Democratic America is simply not prepared for a gold standard...

We'll soon be testing Americans' appetite for spending discipline as Rep. Paul Ryan introduces his plan for avoiding the debt crisis that everyone knows is coming unless we dramatically change our present course. Everyone wants a solution. Few are willing to sacrifice.

Posted by Austin at 4:06 PM | Comments (0) | TrackBack
Category(s): Current Market Events, Economy, Inflation Watch
Tag(s): gold, gold standard

Email this post

Repairing the wall of worry

A week ago, I wrote about the fact that the market tends to experience 5% pullbacks quite often, noting that the most recent one is the sixth such pullback during the current two-year current bull market. One of the main points of that post was that regardless of the recent events in Japan and the Middle East/North Africa, the market was "overdue" for such a pullback, simply based on how far it had gone up since the last one.

That may seem odd to some, but the basic idea behind it is straightforward. Stock market activity is driven by three main components:

• Valuation (are stocks over/under-priced?);
• Monetary conditions (interest rates and changes to the money supply); and
• Psychology/Sentiment (are investors excessively bullish or bearish?).

Clearly, each of these pieces influences the others. And there are many ways to measure these various pieces, with various measures sometimes conflicting. So even knowing these are the three main drivers of the market doesn't simplify the task of predicting what the market will do next very much.

Getting back to the 5% pullback idea though, these pullbacks are important due to their impact on market sentiment. As the market goes higher and higher without any type of pullback or correction, there's a tendency for investors to become excessively optimistic. This shows up in all sorts of sentiment measures, such as bullish/bearish surveys and so forth.

You've probably heard the old market saying, "The market likes to climb a wall of worry." Well, when everyone gets bullish, there isn't much worry for the market to climb. Fortunately, this can be corrected rather quickly, as has been shown over the past three weeks or so.

Mark Hulbert wrote pair of articles for MarketWatch last week demonstrating just how rapidly the wall of worry has been rebuilt.

In the first, published last Tuesday, he noted that the market was then higher than before the March 11 Japanese earthquake. Yet sentiment among the market-timing newsletters he tracks had plummeted. Before the earthquake, these timers were collectively recommending that their readers be 49.1% invested in stocks. As of last Tuesday morning, that percentage was 15.8%.

Perhaps even more telling, the last time these timers were that cautious/bearish as a group was mid-September of last year. For those of you paying close attention, yes, that was precisely the point from which the recent uninterrupted rise in the market began. That was 1,500 Dow points ago. The fact that these timers were just as gloomy last week as they were six months ago, when the market was considerably lower, is a good thing. It indicates that wall of worry has been quickly rebuilt.

(It may seem odd that we consider these timers becoming more bearish as a positive thing. But as a group, they tend to be wrong. So this is a contrary indicator — when this group gets bearish, that's usually a good sign.)

Hulbert followed up his Tuesday article with another a day later that reported on how the behavior of corporate insiders had changed in recent weeks.

The idea behind using corporate insiders as an indicator is that they should know better than anyone what the true prospects are for their company. As a result, when they are selling heavily as a group, that's usually a bad sign for the market going forward. When they are buying heavily (or selling less heavily), that's usually a good sign. There are a number of caveats, but that's the gist of it.

So how have insiders responded to recent events? They've cut their selling by half. The last time the sell/buy ratio was as low as the most recent reading was...wait for it...last September.

Now, in the interest of full disclosure, I'm not overly impressed with either of these indicators and usually don't pay them much more than a passing glance. So I don't want anyone to get overly euphoric about them, in and of themselves.

Rather, I wanted to build on the idea from my post a week ago, showing why the market experiences (and needs) these relatively frequent small pullbacks. They serve as checks to the natural tendency for investors to become too optimistic as the market rises. These sharp pullbacks serve to shake out some of that excess bullishness. In so doing, they tend to prolong bull markets.

Recent events appear to have rebuilt the wall of worry in a relatively short amount of time. From a "what will the market do next" standpoint, while there are certainly no guarantees, knocking market sentiment reading down a few notches has to be seen as a positive development.

Posted by Mark at 10:40 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): market pullbacks, market sentiment, wall of worry

Email this post

5% market pullbacks

Over the past month or two, I've mentioned several times in conversations that the market was "overdue" for some sort of pullback. What impact has that had on my personal investing, or the information we've discussed here and in the Sound Mind Investing newsletter? Absolutely none.

Confused? Let me explain. As the chart below shows, we are currently in the sixth decline of at least 5% since the current bull market began two years ago.

Surprised? It only seems like the market has gone straight up for the past two years. In reality, these minor pullbacks happen quite often. Think of them as "the pause that refreshes." Two steps forward and one step back is absolutely normal behavior for the stock market.

Now if you look at this chart and the frequency of these pullbacks, what stands out? Notice the length of the uninterrupted blue line from Sep-10 to Mar-11. Big gains over an extended period without a significant pullback. That simple fact is what has made me feel like some sort of pullback was likely before too long.

If that's true though, then why not do something about it? Well, the main reason is that I just don't have any confidence in our ability to play "the trading game" successfully. Those short-term movements aren't what we're about. It's difficult to know when these pullbacks are coming (note the variation in length between them). And the consequences of riding them out are pretty insignificant (note the overall rising line of the chart, despite these relatively frequent pullbacks).

Here's some analysis from Birinyi Associates, who created the chart (hat tip to The Big Picture, where I saw it):

What is perhaps more encouraging is the fact that 5% declines do not usually result in a further 10% decline, and a bear market is even less likely. An initial 5% decline, such as the one beginning on 2/18/11, only results in a correction (10% decline) 33% of the time, and in only 11 of 106 instances has a 5% decline turned out to be a bull market top.

It's common sense that all bear markets start with a drop of 5%. But only 10% of those 5% drops turn into bear markets. The other 90% don't. Two-thirds of them don't even continue on to 10% official correction territory.

So while last week was a tough week and some people are understandably nervous, there really isn't anything at this point to suggest this is more than a normal pullback within a continuing bull market. In fact, I would go as far as to suggest that even if the horrendous earthquake in Japan hadn't happened, the market would have still found a reason/excuse to sell off by 5% or so soon. It's just the nature of the market.

Posted by Mark at 10:45 AM | Comments (0) | TrackBack
Category(s): Current Market Events, Investing Principles
Tag(s): market correction, market pullbacks, market volatility

Email this post

Panic selling in an erratic stock market rarely pans out

We've written about this before, but it's worth a quick reminder today:

It rarely pays to sell into a panic.

Need proof? Consider this data from Mark Hulbert's column today. Ned Davis research looked at the worst 28 political/economic crises from 1940 to 2001 and found that, on average, six months later stocks were higher than they had been before the event. (None of these were minor — think the Fall of France in 1940, Pearl Harbor, 9-11, etc.)

After gaining roughly 34% since last July's correction low, the market is now off about 5% (including this morning's losses). Even without the recent events in Japan and the Middle East, this would be perfectly normal behavior after a positive run like we've seen.

As investors, there doesn't appear to be any particular reason for alarm.

As human beings, watching the suffering in Japan...that's another story. But it's important that we learn not to let our emotions spill over into our investment decision-making when confronted with situations like this.

Posted by Mark at 1:55 PM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

How this bull market stacks up to history

"Happy birthday, dear bull market, happy birthday to you!"

Two years ago today the stock market abruptly turned the corner and shifted from mega-bear mode into mega-bull mode. Many were left flat-footed, disbelieving the change. (Some are still flat-footed, disbelieving the change!) This is how the stock market works. At the moment of maximum pessimism, the phoenix begins to rise from the ashes.

In honor of the bull's birthday, Mark Hulbert has analyzed a number of key statistics comparing this bull market to past bull markets. Here are a few that stand out:

• Since the beginning of the last century, there have been 33 bull markets prior to the current one. It turns out that only 14 of those 33 bull markets even lived to their second birthday.
• Of the 14 prior bull markets that lived at least two years, on average, the Dow was ahead 43.6% on their second birthday. That's just half the Dow's two-year gain of 86.7% in the current bull market.
• The current bull market in its first two years gained more than all but two of the past 33 bull markets.
• Of the 14 prior bull markets that did make it to their second birthdays, on average, those bull markets lived to be over three years old.

Add it all up and what does it mean? Hard to say. One thing seems clear though. Unprecedented stimulus and central-bank liquidity have led to one of the more dramatic two-year bull runs of the past century.

The Fed continues to keep interest rates extremely low, while simultaneously continuing its massive bond purchases via the QE 2 program. Will that be enough to keep this bull market running for a third year? It's impossible to say. But long-time readers know that I personally put a decent amount of weight on the old adage, "Don't fight the Fed." When liquidity is high, that money has to flow somewhere.

My guess (and it is just that) is that this bull market will continue to roll along until the Fed starts tightening, either by raising rates or ending its "quantitative easing" policies. But the past few years have been filled with surprises, so another is certainly possible.

Posted by Mark at 11:50 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): bull market, market history

Email this post

Will the stock market soon reach a new all-time high?

That's a question that we ask and answer (to the degree possible) in the current issue of the Sound Mind Investing newsletter.

Of course, no one can know for sure what's ahead — as I discussed in a conversation yesterday with host Bob Crittenden on The Meeting House from Alabama's Faith Radio.

You can listen to a portion of that conversation by clicking the arrow on the audio player below (9 min.).

Posted by Joseph at 1:20 PM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): investing predictions, investing principles, new stock high, stock market

Email this post

Putting rising bond yields in perspective

After receiving a few questions in response to yesterday's bond-related post, I thought it might be helpful to offer some additional thoughts here today.

There's quite a bit we can learn from recent activity in the bond market, so let's start there with a few specifics.

Over the past three months, the 10-year Treasury yield has gone up by 1%, from 2.65% on November 10 to 3.66% yesterday. That's a very significant rise in a short period of time.

Bond Investing 101 (as summarized in our current article, The Bond Basics You Need to Know in 2011) tells us that when bond yields rise, their prices fall. This is indeed what we've seen. The degree of the price decline depends primarily on the length of the bond. The longer the maturity, the greater the price decline.

We can see this clearly in the returns of various bond funds over the past three months. Vanguard's Intermediate-Term Bond Index fund has lost -5.73% over the past three months, while the company's Short-Term Bond Index is down just -1.56%. (This is a vivid illustration why we encouraged our readers to shorten their bond maturities in anticipation of rising interest rates.)

What about TIPS? TIPS are "inflation-protected" bonds that are supposed to adjust to keep up with inflation. But this doesn't mean that they can't go down in value. There are two basic forces at work with TIPS.

First, they do in fact respond to increases in CPI-measured inflation, helping their owners maintain their purchasing power in inflationary times. Unfortunately, the second force is old fashioned supply and demand. As investors see higher interest rates coming (or think they do, at least), TIPS are subject to the same selling pressure as regular bonds. So while TIPS help insure bond portfolios against rising inflation, they're still subject to swings in interest rates.

Back to the overall bond landscape. The 1% rise in rates over the past three months is quite steep. It's not typical for bonds to move that far, that fast. At this recent pace, the 10-year Treasury bond would be yielding 7.65% a year from now, up from 3.66% today. I'm not aware of anyone who expects that to be the case.

In fact, it's important to recognize that while the higher yields of the past three months have bond investors spooked, the 10-year Treasury note has almost exactly the same yield now as it did one year ago!

On February 9, 2010, the yield was 3.67%. Yesterday, it was 3.66% (see chart at left). So this recent rise in interest rates has simply offset the significant drop that occurred as investors poured money into bond funds last year.

The main takeaway is not to get overly worked up about short-term changes in bond yields (and by extension, losses in bond funds). We don't want to be blind to the larger trends, which is why we have suggested shifting bond money to the short-end of the yield spectrum. But these swings in interest rates happen, and usually they don't signify a whole lot.

Further, all it would likely take to reverse the upward move in bond yields is for Europe to announce a new round of trouble. That, or a dozen other catalysts, could easily prompt investors who've been cautiously pulling their money out of bonds and putting it into stocks to reverse course, sending bond yields lower again.

In contrast, if you're following SMI's approach and investing based on a long-term, personalized investing plan, you don't need to sweat every little blip in your bond returns (just as you shouldn't sweat every little blip in your stock returns). Hopefully this helps explain how you can keep an eye on some of these trends without becoming overly concerned about them.

Posted by Mark at 9:20 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): bond funds, bonds, interest rates

Email this post

More fuel for the bond "bad news" bonfire?

The primary purpose of having bonds in your portfolio is stability. Price appreciation comes on the stock side. Bond holdings, in contrast, decrease portfolio volatility. "Bond ballast" helps keep you from abandoning the markets in fear during times of maximum market stress.

This isn't the only way to approach investing, of course, but it's how we approach it at SMI. In our strategies, we don't reduce our bond holdings simply because some people think bond prices are vulnerable. They may be, but even in such circumstances, bond portfolios — if properly positioned — are still going to be less "risky" than stock holdings in terms of their vulnerability to big losses. So don't throw your ballast away just because it looks less stable than it did a year ago. It's still going to help keep your emotional boat from tipping over in a crisis.

So, just to be clear, we're not encouraging anyone to reduce his or her bond holdings as a result of the information presented below. Our approach is to deal with an increase in bond risk by shifting toward the short-end of the yield curve, not by reducing bond holdings (if indeed, bonds are present part of your long-term plan).

On to current events. The chart below shows the yield of the 30-year Treasury bond over the past 24 years (this chart was published recently in the Los Angeles Times). It shows the fairly steep rise in yield from a panic low of 2.5% in January 2009 to the recent 4.70% yield.

As you can see, there have been plenty of ups and downs over the past two decades, but the steady trend has been toward lower yields. As this month's SMI cover article points out (The Bond Basics You Need to Know in 2011), lower yields mean higher bond prices. In other words, we've had a huge bull market in bonds as a result of these falling yields.

But, as the chart vividly shows, that downward trend line has been in jeopardy lately. In fact, the 30-year Treasury bond ended last Friday with a yield of 4.732%, effectively crossing that long-term trend line for the first time in many years. These "technical" trends aren't gospel, but there's no way to paint this as anything other than a potentially ominous sign. (See my October 2009 article, Re-Evaluating the "Safe" Part of Your Portfolio.)

That said, the end of a falling trend in interest rates is not necessarily the same thing as a new rising trend. Bond guru Bill Gross of PIMCO, while warning many times over the past year that the end of the bond bull market is near, has also said that he doesn't anticipate Treasury yields to rise rapidly (he expects a gradual rise).

Time will tell.

Posted by Mark at 9:55 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): bonds, investing strategies

Email this post

Using the right index

It often surprises newer investors to learn that the Dow Jones Industrial Average (DJIA) is largely ignored by most market participants. The Dow results still get reported on the nightly news, so why is it shunned?

Here's what I wrote about the Industrial Average in a May 2009 article (subscribers' link) in the Sound Mind Investing newsletter:

Although this is the best known of all market indexes (and the one that gets the most attention in news reports), "the Dow" is actually the least useful major index.

A significant problem is that it measures the performance of only 30 specific companies. While these 30 are selected carefully to reflect the fortunes of the general economy, a sampling of 30 stocks simply can't be as accurate a barometer of large-company performance as an index that includes hundreds (or thousands) of stocks.

The fact that the Dow is price-weighted (higher-priced stocks have more influence than lower priced ones, regardless of market capitalization) also hinders its usefulness.

I came across a perfect example of these problems last week on the Bespoke Investment Group site. They noted that back in June 2009, the keepers of the Dow replaced General Motors with Cisco, one of the nation's largest technology firms.

Replacing an auto manufacturer with a premier technology company wasn't what got people talking about that move. Rather, it was the debate over whether Apple should have been added rather than Cisco.

How big a difference would that substitution have made? Would you believe 1,000 points in less than two years?

When dealing with an index of so few stocks, such cases aren't as difficult to find as one might suspect. A couple of years ago, investment researcher Norman Fosback pointed out that the Dow would be roughly twice as high today had IBM not been removed from the index in 1939.

The DJIA's narrow focus is the primary reason most modern investors look to other indexes. The S&P 500 is probably the most widely followed today. However, at SMI we prefer the Wilshire 5000 (PDF), given that it represents the performance of roughly 99% of the U.S. domestic equity market.

Posted by Mark at 9:25 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): market indexes

Email this post

And the forecast is for...

Here in Georgia where I live, we got six inches of snow yesterday morning. Very unusual for this part of the country. But the weather forecasters were dead-on in their predictions, so we were prepared and are now cozy here with plenty of provisions and, if need be, a back-up source of heat.

The folks who forecast weather for a living are usually pretty accurate (probably because they're dealing with events only a few hours or days away). Regrettably, the same can't be said for those who forecast the economy and the stock market, as the Wall Street Journal's Jason Zweig points out.

Every January, hordes of highly paid experts attempt to predict what the economy and the markets will do in the coming year. Later in the year, nearly all of the forecasts turn out to be wrong....

Why do people with years of experience, massive expertise and mountains of data at their disposal so often get the future wrong?

First and foremost, the future is the realm of surprises; no one, no matter how expert, can reliably foresee what will happen and how people will react to it. As the economist Friedrich von Hayek said in his lecture "The Pretence of Knowledge" when he won the 1974 Nobel prize in economics, "in the study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process…will hardly ever be fully known or measurable."

Forecasts also go wrong because they tend to be either too tame or too extreme. For a forecaster, there is little point in differing slightly from the consensus prediction. No one gets fired for being in the middle of the pack, nor do forecasters get much credit for being a little bit less wrong than their peers. If a forecaster is going to deviate from the average, he might as well go all the way.

Therefore, while most pundits tend to cluster around a safe consensus, a few stake out the risky but potentially lucrative ground of extremely bullish or bearish predictions. If they turn out to be right, their accuracy will seem miraculous and they will be famous; if they turn out to be wrong, most people will forget.

Jason Zweig offers a few ideas for getting some practical use out of usually errant forecasts, such as averaging various forecasts ("errors will frequently offset one another," he says). But in the end, despite all the complex formulas and computer modeling forecasters use, financial forecasting comes to down to trying to predict the unpredictable.

Zweig's ends his piece by quoting G.K. Chesterton:

"The real trouble with this world of ours is not that it is an unreasonable world, nor even that it is a reasonable one. The commonest kind of trouble is that it is nearly reasonable, but not quite.… It looks just a little more mathematical and regular than it is; its exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait."

Because no one can know the future, we always urge you to keep your stock portfolio well-diversified and your bond portfolio (if any) as insulated as possible.

After all, no one knows what kind of inexactitude and wildness may lie just around bend.

Yesterday on The Meeting House from Alabama's Faith Radio, I talked with host Bob Crittenden about the difficulty (if not impossibility) of making consistently accurate market predictions. You can listen to a portion of that interview below (14 min.).

Posted by Joseph at 11:55 AM | Comments (0) | TrackBack
Category(s): Current Market Events, Economy
Tag(s): diversification, forecasts

Email this post

Bond funds take a beating

The Wall Street Journal offers an update on something SMI's executive editor Mark Biller warned about in our Oct. 2009 issue (as well as several times since): "safe" bond funds can suffer short-term losses.

Bonds are supposed to be safe, but the world's five largest bond mutual funds have all posted losses in the past two months — with three of them losing more in December than in November....

A selloff in U.S. Treasurys is spreading to most bond sectors, including corporate and municipal bonds. The yield on the benchmark 10-year Treasury, which moves in the opposite direction of price, has jumped about a full percentage point in the past month on fears that aggressive monetary and fiscal stimuli could trigger inflation and higher interest rates down the road....

While the five biggest bond funds are still up for the year, they have performed poorly of late. The $250 billion Pimco Total Return Fund, the world's largest bond fund, lost 3.42% from Nov. 4 through Dec. 17, compared with a 2.51% loss in the BarCap U.S. Aggregate Bond Index over the same period, according to Morningstar. The second- and fourth-largest bond funds, the $89 billion Vanguard Total Bond Market Index Fund and the $38.4 billion American Funds Bond Fund of America Fund, respectively, have lost 2.64% and 2.79%.

The losses were smaller in the $38.3 billion Vanguard Short-Term Investment Grade Fund, which lost 0.91% over the period in part because of the fund's shorter-duration securities, and $43.7 billion Templeton Global Bond Fund, the world's third-largest, which lost 1.29%....

Kenneth Volpert, head of Vanguard's taxable-bond group, attributes the losses in Vanguard's bond funds to the rising-rate environment.

The WSJ suggests that bond yields are rising because of the expected impact of "aggressive monetary [i.e., Fed] and fiscal [i.e.. White House/Congress] stimuli" that are pumping lots of money into the economy. That's one possible explanation, though as this post from last week suggested, some observers feel the recent rise in bond yields could merely be a return to more "normal" historical bond yields. As the economy eventually recovers to health, one would expect yields to rise from the record lows of the past two years.

Either way, as yields rise, bond values fall. No one wants to pay $1,000 for a bond paying 3% interest if there are new $1,000 bonds paying 5%, so the price of those older bonds has to drop to make them competitive with the new reality of the marketplace.

This is why long-term bonds suffer the most as rates begin to rise — and it is why we've been steering our readers away from long-term bond holdings for some time now. Shorter-term bonds, in contrast, suffer from rising rates for only a brief time, so they're better choices in times of rising rates.

We'll have more on this in our annual allocation article — coming soon in the January issue of SMI!

Posted by Joseph at 1:50 PM | Comments (0) | TrackBack
Category(s): Current Market Events, Mutual Funds
Tag(s): bond funds

Email this post

Rising rates? That's a good sign, Prof. Siegel says

Interest rates on U.S. Treasury notes have jumped sharply in the past month, leading some pundits to argue that the rising rates are evidence that the Fed's QE2 policy is backfiring.

On the contrary, says Jeremy Siegel of the University of Pennsylvania's Wharton School (and author of Stocks for the Long Run), writing in yesterday's Wall Street Journal (subscribers' link):

Long-term Treasury rates are influenced positively by economic growth — which encourages consumers to borrow in anticipation of higher incomes and causes firms to seek funds to expand capacity — and by inflationary expectations.

Long-term Treasury rates are affected negatively by risk aversion: Seeking a safe haven, investors pile into Treasury bonds, running up their prices and lowering their yields.

The Fed's QE2 program has raised expectations of growth and inflation, sending long-term Treasury rates up. It has also lowered risk aversion, which implies rising long-term rates.

The evidence for a decline in risk aversion among investors is the shrinkage in the spreads between Treasury and other fixed-income securities, the strong performance of the stock market, and the decline in VIX, the indicator of future stock-market volatility. This means that expectations of accelerating economic growth — and a reduction in the fear of a double-dip recession — are the driving forces behind the rise in rates.

Siegel concedes that growth expectations have also been boosted by the tax deal currently before the Congress, "[b]ut long-term Treasury rates were rising even before Mr. Obama announced his policy switch."

The Wharton professor isn't the only one who thinks the combined impact of Fed's QE2 policy and the tax deal will juice the economy. PIMCO, which runs the world’s largest bond fund, last week upped its growth estimate to a range of 3.0-3.5 percent (by the end of 2011) from an earlier estimate for 2.0-2.5 percent.

PIMCO CEO Mohamed El-Erian told Bloomberg the revision came in light of the "massive amount" of fiscal and monetary stimulus expected to be pumped into the economy.

Posted by Joseph at 9:05 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): economy, interest rates

Email this post

Do markets really hate uncertainty?

In a column for Bloomberg, Barry Ritholtz (who blogs at The Big Picture) takes on the oft-repeated saw that "markets hate uncertainty."

Wall Street has a sweet tooth for such investing maxims.... The problem with these supposed truisms is they are no more accurate than the flip of a coin. A closer look at this uncertainty meme reveals it to be a false-ism....

Could markets function without uncertainty? It takes only a little thought to realize that markets actually thrive on doubt, imperfect information and a lack of consensus.

Uncertainty drives the market's price-discovery mechanism. Investing requires there to be differences of opinion. When there is broad agreement as to an asset's fair value, trading volume falls. Without any uncertainty, who would take the opposite side of your trade?

History teaches that whenever the opposite occurs — when certainty overwhelms uncertainty — the herd tends to be wrong. In rare instances, when there is a near-total lack of uncertainty in the market, the outcome is usually a spectacular disaster....

When we discuss uncertainty, what we are really discussing is risk. All unknown outcomes contain risk, and therein lies the possibility of loss. Risk is inherent in the concept of uncertainty. However, anyone looking for performance must embrace risk, for without it, there can be no reward....

[U]ncertainty is where the money is. No uncertainty, no risk; no risk, no possibility of outperformance....

Want some certainty? Go buy yourself Treasuries. You can pick up a very lovely two-year bond yielding 0.41 percent.

Ritholz has a good point — one we've made many times in the pages the Sound Mind Investing newsletter (and on this blog): the only certainty is uncertainty. No investing strategy that involves risk can have a guaranteed outcome.

Still, we can make informed decisions about probable outcomes. For example, it is probable that the market will perform well over the months ahead because of certain cyclical factors we know are at play, along with the Fed's QE2 policy that's designed (among other things) to raise asset values.

But, of course, it is possible that something that's probable doesn't come to pass.

Thankfully, over the past two decades SMI has been right more than wrong when weighing the probabilities and making judgment calls on such things as fund choices and asset allocation. That is certainly something to thank God for during this Thanksgiving week (and beyond) — and, of course, we're grateful for our SMI readers who put their trust in us.

Of these things, at least, we can be quite certain indeed.

Posted by Joseph at 4:05 PM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): stock market, thankfulness

Email this post

Links round-up

Rather than writing a post today on a single topic, I want to alert you to several interesting items from recent days.

First, at the Wall Street Journal, Brett Arends observes that many dividend-paying stocks look considerably better than bonds being issued by the same companies, yet the public keeps piling into bonds.

Arends also has a somewhat scary analysis of the "Retirement Disaster Ahead." Bottom line: many people are still counting on unrealistic future investment return numbers. As a result, they aren't saving nearly enough for the type of retirement they expect.

A recent auction of TIPS (Treasury inflation-protected securities) sold notes with a negative yield (-0.55%)! Seems strange, but Mark Hulbert explains why that makes sense, given that these TIPS can be thought of as an insurance policy protecting you against the risks of both severe deflation and hyperinflation.

On that same topic, Eric Jacobson of Morningstar adds some good context to this TIPS news, explaining that if annualized inflation over the next five years is higher than 1.52%, the buyers of these negative-yielding bonds will wind up winners.

While the big twin news events of last week were Election 2010 and the Fed's QE 2 announcement, there was also a surprisingly good (or at least, less bad) jobs report. As the Vanguard video below makes clear (an interview with Vanguard's chief economist Joe Davis), there is a reasonable "case for cautious optimism" on the economy at this point.

Finally, new rules about reporting the cost basis of investments are going to start kicking in for brokerages next year. This will mean brokerage customers have some decisions to make soon. So be watching your mail for information from your broker. This information could have important implications, particularly if you have money in a taxable investment account.

Posted by Mark at 9:10 AM | Comments (0) | TrackBack
Category(s): Current Market Events, Economy, Taxes

Email this post

What does Election 2010 mean for investors?

SMI's assistant editor Joseph Slife talked about the impact of Election 2010 — and other current factors — on the environment ahead for stock-market investors on yesterday's edition of The Meeting House from Alabama's Faith Radio.

Use the audio player below to listen (18 min.) or download an mp3 (right click/save as). The host is Bob Crittenden.

Posted by Matthew at 12:10 PM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): radio

Email this post

Elections and returns

In the October issue of the Sound Mind Investing newsletter, we reported on The Impact of the Election Cycle On Annual Seasonality (subscribers' link). Here are a few excerpts:

Each year contains a six-month period that is generally "favorable" for stocks (November through April) followed by a six-month period that's generally "unfavorable" (May through October).... Stock market strength/weakness [also correlates with] the four-year [presidential election] cycle closely enough that, over time, clear trends have become evident....

[T]he unfavorable period of [a president's second year] (corresponding to the six months leading up to the midterm elections) has been especially bad, and the favorable period of year three (i.e., the six months following midterms) has been especially good.

In other words, we are coming out of a period that, historically, has been tough sledding for the market and entering a six-month period of time when the stock market has shown particularly strong performance.

Why market returns typically improve following a mid-term election is anyone's guess. And, of course, past performance is no guarantee of future results (as the legal disclaimer goes).

In this particular case, some of the push higher surely is driven by the fact that it looks likely (but it ain't over till it's over) that Republicans will take the House half of Congress. They might even take the Senate.

Many (not all) investors, unhappy with what they see as an overly activist government — or at least a government that has created significant uncertainties in the marketplace — are hoping for what Washington watchers call "gridlock" (i.e., little gets done because the policy differences are just to broad to reach agreement).

But as a J.P. Morgan official said last week (quoted yesterday in the Wall Street Journal), "Gridlock surely promotes the status quo but that is not great in a time when action is needed." In other words, stopping something is not the same as doing something.

From the WSJ:

The main question is what a gridlocked Washington would do if faced with a new recession or financial crisis. But other issues abound: the future of Fannie Mae and Freddie Mac, which control a huge proportion of the nation's mortgages, Medicare and Social Security costs, trade disputes and other issues involving China, the moribund housing market, unemployment.

Gridlock, if it occurs, may not emerge right away, however. Keep in mind that before the new Congress is seated until January, the lame-duck Congress will still have several weeks in which to pass bills to the president's liking — such as extending tax relief only for certain taxpayers. Doing so could leave many investors with significantly higher tax liabilities (subscribers' link) in 2011. (Note: The make-up of the Senate could change slightly before January because of a special election in which the winner will be sworn in shortly after the election is decided.)

Also in the mix in the weeks ahead: the final report (due Dec. 1) from the president's deficit commission (the National Commission on Fiscal Responsibility and Reform). It is unlikely the outgoing Congress will deal with any suggestions therein, but the report's recommendations could set up some bruising legislative battles in the new year.

What all this means for the investing climate no one can tell, especially with the Fed pumping even more money into the economy. One thing seems likely: there will be no shortage of confrontations, speculations, and congressional investigations.

Our advice? Find an investing approach your nerves can handle and do your best to tune out the noise.

I talked about some of these issues in an interview that will air this afternoon on The Meeting House from Alabama's Faith Radio. Host Bob Crittenden played a 3-minute preview of that conversation on yesterday's program. Listen below.

Posted by Joseph at 9:35 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): Election Day, radio, tax cuts

Email this post

Bullish potential

It's been three years now since the stock market peaked in the fall of 2007. During those three years, we've suffered terrible financial and emotional damage from a punishing bear market, watched our economy go through its steepest contraction (a decline of 4% in GDP) since the Great Depression, and been awakened to the fact that our financial system had been hollowed out and was/is in very shaky condition.

That's a lot to process and enough to turn even the most optimistic sorts into pessimists. But on top of that, we're watching a slow-motion government financial train wreck unfolding before our eyes. Huge deficits and debt are piling up with seemingly no willingness to recognize the extreme challenges about to hit our system in a decade or so (much of it in the form of increasing Social Security, Medicare, and health care obligations).

For three years now, many investors have been marinating in the toxic stew described above. Against that backdrop, how could anyone be bullish on stocks?

The key is recognizing that stock prices are not merely a reflection of current conditions. Rather they are a reflection of future expectations, and even more precisely, future expectations relative to current business valuations.

In other words, a change in expectations from "imminent Armageddon" to merely "terrible" can send the stock market soaring if stocks have been priced for the former. That's what we saw through 2009. And should the improvement go from "terrible" to "not so bad," that trend may have plenty of room to continue.

I'm not going to try to build a comprehensive bullish case in this post, but rather just relay some of the interesting bullish points I've noticed in recent weeks. I know it's hard to let this type of positive information in when many of us are still stuck in a reflexively defensive/pessimistic posture from the events and fears of the past few years. But for the first time in a while, it seems to me that the bullish case is looking pretty strong.

Let's look at some of these bullish factors. First, the market finally broke out of a four-month trading range last week by punching through the 1,130 level on the S&P 500. Many Wall Street watchers expected this trading range would be resolved when the market returned to business following Labor Day, and that appears to be happening.

From the March 2009 low of 666 to the April 2010 high of 1,217, the market rallied roughly 83%. It then fell 16% to a low of 1,022 on July 2. That correction was 35% of the prior move (a drop of 195 points — one-third of the prior gain of 551 points). That is a pretty textbook definition of a minor correction, although it certainly didn't feel that way at the time.

If we view this year's correction in terms of common, typical bull market behavior (rather than as the start of a new bear market), it's easier to look forward with more confidence as to what commonly transpires next.

What is that? As our October SMI newsletter piece on the election cycle and annual seasonality (subscribers' link) points out, we're nearly finished with what is typically the worst six-month stretch for stocks in each four-year presidential cycle. And we're on the cusp of beginning what is typically the best six months of that four-year cycle. Since 1950, the six-month period we're about to enter has averaged a gain of 21.8% for a portfolio split evenly between large and small stocks.

If that's not optimistic enough for you, the Stock Trader's Almanac reports that since 1914, the market has averaged a gain of 49.2% from the mid-term-election-year low to the high of the following year. (That's not the product of a few good years either — only four of those 24 instances saw advances of less than 32%.) If we assume the July low of 1,022 is indeed the low for 2010, that would imply a gain to 1,500 by sometime next year would be normal.

Hello? Do you hear anyone talking about a gain back to the levels of the 2007 peak by sometime next year? It sounds crazy, but a further gain of 32% from today's levels would merely be following the normal mid-term election pattern.

Sure, it's great to look at all these historical patterns and technical analysis mumbo jumbo. But is there anything in the fundamentals to support this kind of optimism? It turns out, there is.

The other day, I came across a great article by Jon Markman in which he points out that much of the "September surprise" in stock prices this year has been due to companies solidly beating earnings expectations. But more importantly, he references material from a British money management firm called Collins Stewart that makes a compelling case for stocks advancing strongly on the basis of their likely earnings and current valuations.

As we have noted several times in SMI, earnings estimates are often way too optimistic, thus we're skeptical of valuation methods relying heavily on those estimates. But Collins points out that following bear markets, it takes a while for analyst optimism to return, and in fact their estimates tend to be too low for the first three quarters of bull markets.

Based on the fact that Markman thinks analyst estimates will prove to be too low compared to how earnings come in (which has, in fact, been the case so far through this recovery), he thinks the market's current valuation (12 times expected 2011 earnings) is too low, not too high.

I encourage you to read his full argument, but the short version is that if the average P/E were to rise to just 15 on the back of stronger-than-anticipated company earnings, the market would likely move to around 1,440. (And he notes that when inflation and interest rates are as low as they are currently, P/E's typically wind up around 20, so 15 is hardly a stretch.)

Then he writes:

Before you scoff at this — and who could blame you — credit analysts say that bonds are already trading at levels that correlate with the S&P 500 topping 1,500.

So now we've got:

• multiple long-term historical trends,
• a fundamental earnings-based analysis, and
• the bond market

all telling us that it shouldn't surprise us to see the S&P 500 trading around 1,500 within the next year.

Okay, that's enough. I don't want to overstate the case. As I mentioned at the outset, there's still plenty of risk in this market. The possibility of a "worst case scenario" is still present, as the financial system remains fragile enough that an unexpected shock could still topple it. These bullish factors represent a shifting in the most likely outcome, but not an elimination of worst case scenarios. Risk has been reduced, but certainly not eliminated.

In recent years, the economy took some really tough punches, has been wobbling, but might not actually be knocked out. If that is the case, and we get back to something resembling "normal" again (ideally with our politicians straightening up their spending act) the stock market may have some catching up to do.

As we noted earlier, when the market is priced for a knockout and it doesn't happen, there's room for stock prices to advance. As businesses recover and the global economy (hopefully) continues to find its legs, investors could find themselves surprised by the sun starting to shine through the thick cloud cover they've been living under. It certainly wouldn't be the first time that has happened.

Posted by Mark at 11:55 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): bull market

Email this post

Past as prologue?

Here's an interesting study from Bespoke Investment Group. They went back to 1928 looking for the six-month period where the stock market most closely resembled the six months we've just been through. Then they looked to see what the future held from that point.

See their study and charts here.

Particularly noteworthy is the way that 1959/60 period lined up with both a prior recession and a new "double dip" recession just ahead. That's very similar to the scenario today (no surprise that the stock market responded in similar fashion, I suppose).

As the study points out, it's also very interesting to note that while April 1960 did indeed bring about a dreaded "double dip" recession, the stock market didn't really suffer much from it, declining just 6% from the point we're at now to its ultimate low. And following that second recession, the market was ready to leap higher.

Of course, none of this means anything concrete for the future we face today. But it's interesting to see all these similarities lined up and then realize that the bad outcome for the economy that many are fearing today didn't impact the stock market in that prior period the way most are assuming it would today. (And, of course, we may not even get that double dip recession this time around — the jury is still out.)

It's also interesting to me that in that 1960 example, the pivot point occurred right around the end of October. The seasonality and election cycle influences seem too obvious to ignore, but perhaps I'm reading to much into it. Given our own proximity to the seasonality and election cycle pivot point, that would seem to be encouraging.

Posted by Mark at 1:05 PM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

Of bonds and bubbles, part 2

A couple of weeks ago, I raised the question of whether bonds were looking bubbly. A day later, Bespoke Investment Group published a pair of charts that add another angle to that discussion.

Bespoke's first chart shows that in absolute terms, the rate on 10-year Treasuries is indeed at historical lows (surpassed only during the worst of the financial panic a couple years ago).

However, as we've written before regarding fixed-income yields, the most important number isn't necessarily the apparent yield you earn, it's your net "real" return after inflation is factored in. And on that score, today's inflation-adjusted yields — while below average — are nowhere near the extremes we've seen at other junctures.

These charts don't answer the "bond bubble" question, but they do indicate that when the full economic picture is taken into consideration, current bond yields don't seem that crazy. Bottom-line: if our economy truly is "going Japanese" — i.e., several years of deflation, or at least no real return of inflation — current bond prices may not be inappropriate at all.

The question, of course, is how likely is that deflationary outcome? (Here's a rather technical analysis that concludes the bond market is pricing in a 70% probability of this type of Japanese deflationary outcome.)

Posted by Mark at 11:35 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): bonds

Email this post

Are stocks cheap right now, or not?

This question is more difficult to answer than you might expect.

On the one hand, plenty of observers are ready to declare that stocks are very attractively priced. Most focus on the traditional price-earnings multiple (P/E) we discussed in detail in our June and July SMI newsletters.

Here's an example (from an Associated Press article) of this type of analysis, suggesting that "stocks are dirt cheap now":

Stocks are looking almost as cheap as last year when prices hit 12-year lows — at least according to Wall Street analysts.

It was easy to miss the development amid news of falling home sales, a drooping dollar and sluggish orders for big-ticket goods. But stocks in the Standard & Poor's 500 index now trade at just 11.7 times analyst estimates of operating earnings for the coming year. That is one of the lowest — read cheapest — levels for this key figure.

In fact, this so-called price-earnings multiple is roughly back where it stood at the end of March 2009 just as the market was starting an 80 percent surge.

Thankfully, this AP story does curb its enthusiasm by mentioning the main point we also made in our July story about "forward" P/E ratios: You can't trust analysts' earnings estimates.

Our article showed that between 1995 and 2009, Wall Street analysts as a group expected earnings to grow 14.3% on average. Actual growth? 5.8% on average. That's a pretty big margin of error.

So if we have to take forward P/E ratios with a grain of salt due to the typically over-optimistic forward earnings estimates they contain, what other valuation gauges can we look at?

Brett Arends of the Wall Street Journal has a few suggestions of alternative valuation measures. Unfortunately, they don't paint nearly as optimistic a picture of current stock prices.

In his article, "Why Stocks Still Aren't Cheap," Arends looks at four alternative valuation measures and finds them all saying roughly the same thing — stocks are still somewhat higher priced right now than their long-term averages. Granted, in most cases they are back to the valuations of roughly the mid-1990s. But those aren't bargains when viewed against a longer view of market history.

You can read the article to get the details on each of the four measures he uses. And it's worth noting that he isn't necessarily arguing that stocks have to fall from their current levels. He just isn't buying the earlier argument that today represents a great contrarian buying opportunity.

Posted by Mark at 11:45 AM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

The Hindenburg Omen

I've seen a number of articles recently discussing the so-called "Hindenburg Omen." I ignored them until today because I don't think it's a relevant issue at all. But I've received some reader requests to discuss it, so I'm doing so now.

Mark Hulbert provides the following snapshot of this indicator:

The core idea behind the Hindenburg Omen is that it's bearish whenever there are a large number of both new 52-weeks highs and new 52-week lows on the NYSE.

If we trace the Omen's genealogy even further back, however, we find that it is a direct descendant of an indicator called the High Low Logic Index, which Norman Fosback, editor of Fosback's Fund Forecaster, devised in the 1970s.

In his classic textbook Stock Market Logic, Fosback explained why a large number of both new highs and new lows is bearish: "Under normal conditions, either a substantial number of stocks establish new annual highs or a large number set new lows — but not both.... [When both nevertheless occur], it indicates that the market is undergoing a period of extreme divergence.... Such divergence is not usually conducive to future rising stock prices."

The trouble is that for this Hindenburg Omen, even when properly computed (more on that in a moment) it has a pretty stinky predictive record. Here's Barry Ritholtz's withering response to a recent Wall Street Journal article on the subject:

Now, I'm open to all manner of data analysis. But when you tell me (toward the end of your story) that (emphasis mine): "The Omen was behind every market crash since 1987, but also has occurred many other times without an ensuing significant downturn. Market analysts said only about 25% of Omen appearances have led to stock-market declines that can be considered crashes," you have pretty much wasted my time. Wake me up when you find something with an actual correlation — last I checked, 25% isn't even in coin-flip territory.

Jumping back to Hulbert, he brings up the very valid point that this indicator may not have even triggered under its traditional definition. Originally the threshold for new highs/lows was 5%, then it got reduced to 2.5% (you can read his full article for the details, if you're interested). But there are so many issues that trade on the NY stock exchange now that aren't even operating companies (think closed-end mutual funds, preferred stocks, etc.), there's a real question about the data the current Hindenburg alarmists are citing:

According to Ned Davis Research, the institutional research firm, a Hindenburg Omen would not have been triggered if analysts were to focus just on common stocks. On Aug. 12, for example, the day that this Omen was supposedly triggered, just 0.4% of common stocks on the NYSE hit new 52-week highs, according to the firm.

To summarize, there are plenty of things to be legitimately concerned about in the current economic/market picture. The Hindenburg Omen is not one of them.

Posted by Mark at 9:05 AM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

Are bonds bubbling?

Economists and investing analysts are engaged in a serious debate about whether the U.S. economy is headed toward inflation or deflation. The deflation arguments have picked up speed this summer, fueled by an increase in reports showing that the economy appears to be slowing again.

While the experts remain (sharply) divided about whether we will tip into outright deflation or not, the mere threat of it has had profound implications on the investment scene.

High-quality bonds are one of the few investments that would be expected to perform quite well in a deflationary environment, and investors have been pouring money into bonds like crazy over the past few years (though not necessarily because they believe the deflation story — there are other reasons investors have flocked to bonds as well, such as fear/loathing of stocks, asset re-allocation by aging boomers, etc.).

The incredible surge of money into bonds and bond funds since 2008, coupled with the stark overall performance difference between stocks and bonds over the past decade, has led to intriguing questions: Are bonds in a bubble? Are stocks attractively priced relative to bonds?

Unfortunately, there aren't clear-cut answers, largely because the answers hinge on the way the deflation/inflation economic path unfolds. And contrary to what many experts would have you believe, nobody knows what will happen next.

This chart (click here to enlarge) stunned me when I stumbled across it recently at The Big Picture blog. For some time now, SMI has been warning about the increasing risk of bond funds due to bond valuations getting stretched (see, for example, my October 2009 article, Re-Evaluating the "Safe" Part of Your Portfolio), but I had no idea that Treasury returns over the past decade resembled those of tech stocks during their heyday.

Big Picture author Barry Ritholtz adds the following commentary:

Over the past few months, I have been saying US Treasuries remind me of the dot com stocks circa 1997-98 in three ways:

1) You knew momentum was taking them (much) higher;
2) You knew it was going to end badly;
3) If you were honest, you admitted you had precisely zero idea when the day of reckoning would be.

Plenty of others, though, say this isn't a bond bubble. They would argue this is merely the rational response to looming deflation on the horizon.

While acknowledging that it's unknowable at this point how this will turn out (future deflation will mean bonds continue gaining, whereas avoiding deflation and a legitimate turn towards economic recovery will potentially expose them to grave danger), it is interesting to note that this long "reversion to the mean" process of stocks becoming cheaper and bonds becoming more expensive has led to valuation conditions we haven't seen in some time.

For example, consider this chart of the Dow Jones Industrial Average Dividend Yield minus the 10-Year Treasury Yield (courtesy of Bespoke Investment Group). The huge amount of money flooding into Treasuries has pushed their yields below the yield currently being offered by the Dow's stocks. Aside from a brief spike during the financial panic, this condition hasn't been seen in nearly 50 years.

Whatever you think about the underlying merits of it, fund flows out of stocks and into bonds have been breathtaking. USA Today reports that since the beginning of 2008, bond funds have had $601 billion of cash inflows, while stock funds have seen $240 billion in outflows.

But here's something to keep in mind: As headlines like this one from the New York Times become more common — "In Striking Shift, Small Investors Flee Stock Market" — remember that small investors usually aren't "ahead of the game" when it comes to timing their investment moves. More often than not, they do things at exactly the wrong time.

Posted by Mark at 12:55 PM | TrackBack
Category(s): Current Market Events

Email this post

'Unusual uncertainty'? Par for the course

Federal Reserve chief Ben Bernanke rattled markets and raised eyebrows yesterday when he told the Senate Finance Committee the outlook for the economy is "unusually uncertain."

Of course, economic uncertainty is nothing new — and therefore not all that unusual. But present-day uncertainty tends to be very sharp in our minds while previous times of uncertainty have faded in our memories.

Last week, I spoke with radio host Bob Crittenden about the certainty of uncertainty on "The Meeting House," a program airing on Alabama's Faith Radio.

You can hear that segment below (14 min.) — or download an mp3 (Windows users: right click, then "save link as").

Posted by Joseph at 9:50 AM | Comments (0) | TrackBack
Category(s): Current Market Events, Economy
Tag(s): economy, radio

Email this post

When Treasuries are hotter than stocks

The U.S. government has never been more in debt, and some economists see fiscal disaster ahead. Even so, the hottest investments going are... (wait for it!): U.S. Treasury notes and bonds — much to the consternation of economists and analysts who predicted otherwise.

The New York Times tells the story:

In a reprise of the flight to safety that occurred during the financial crisis of 2008 and early 2009, people have been parking cash in Treasuries and fleeing stocks, which, of course, have had better long-term returns historically....

This time around, the great cash migration started with the debt crisis in Greece and elsewhere in Europe, not in the United States, but the effects on the American stock and bond markets have nonetheless been severe.

Last month, for example, the Standard & Poor's 500-stock index dropped 8.2 percent....

For people holding Treasury bonds, it's been one of the best of times. In May, long-term Treasury mutual funds outperformed every traditional category of stock fund, according to Morningstar data, returning 5 percent....

[A] vast majority of economists and market strategists were forecasting a different chain of events. Treasury yields were universally expected to be rising, not falling, as the United States recovered from a deep recession. The domestic economy is, in fact, growing, and corporate profits have been rising, but the European crisis has overturned many expectations.

All of which goes to show that the future — even the short-term future — is tough to predict. In fact, in some ways the short term is more difficult to predict than the long term.

Here's the way the NYT sums it up:

[I]t would appear that there is some reason for long-term optimism for stock investors. For the short run, alas, more volatility is probably in order.... Unless you're focused on a distant horizon, it may be a difficult summer.

If you are focused on a distant horizon, it may be best to just ignore the market and focus instead on having some summer fun.

Posted by Joseph at 9:25 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): safety, Treasuries, volatility

Email this post

Are stocks currently safer than bonds?

That's the question being raised (and answered) by Chris Davis, head of the Davis Funds. He says the answer is "yes" (Marketwatch has the story).

Davis (left) thinks bonds may be okay over the next year or two — the bond bubble (as he sees it) could last another couple years. But he thinks stocks are a safer haven when looking out over the next decade.

It's a significant warning — and not an unfamiliar one for SMI readers. We've been beating the "Bonds-are-starting-to-look-scary, given-that-they're-the-supposedly-safe-part-of-your-portfolio" drum for a while now.

Last October we urged our readers to re-evaluate the safe part of their portfolios. And in this month's issue, we look at buying individual bonds rather than bond funds (subscribers' link) as one potential solution to the same problem Davis is concerned about: a future of rising interest rates.

Who is Chris Davis and why should we care what he thinks? Here's how MarketWatch describes him:

While Davis may not be a household name to many investors, he represents a long and storied brand in the fund business, a third-generation fund manager whose firm runs $65 billion in assets, and whose management acumen is widely hailed as being a model of sound thinking.

That doesn't necessarily mean Davis is right. But he adds another angle to the theme we've been warning about for a while now, which makes the Marketwatch article worth a quick read.

Posted by Mark at 9:35 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): bonds, safety, stocks

Email this post

The valley of fear

The amount of fear in the market lately has been tremendous. That's a significant signal. Analyst Don Hays says the market has reached this level of fear (as indicated by certain tracking indicators) only seven times in the past 24 years! And guess what? Each of those times "produced outstanding investment junctures over the next 6-30 months." In other words, the high level of fear signaled significant buying opportunities.

That may not be the case this time around. No one knows. Perhaps past precedents no longer apply. But that always seems to be the case when fear reaches these levels. It's why seasoned investors regard "It's different this time" as four very dangerous words.

There are two primary ways to invest successfully in the stock market over time. One is to be an extremely nimble trader — which is exceptionally difficult. The other is to be a long-term investor. That's not easy either, but for a different reason.

The reason making money as a long-term investor is tough is that it requires an investor to ignore times of fear such as we're going through right now. You have to stay the course when others panic. Moreover, taking a long-term approach suggests that you should lean into the wind and be a buyer at times like these. No easy task.

Which game are you playing? The short-term trading game? Or the long-term investing game? Like it or not, you can't straddle the line between the two. If the urge to do so is overwhelming, maybe your asset allocation is tilted toward a greater level of risk than your true risk tolerance is willing to permit.

Knowing what it takes to succeed as a long-term investor is what drives me to keep putting money in the market despite current fear and volatility. For all I know, this market may keep going down for awhile. But even in that scenario, I'm still comfortable — okay, that's not the right word — maybe committed? — to a course that says, "This is my long-term risk capital, and I'm going to keep it working in the market."

Sure, I'll occasionally be wrong following this approach. But if history is any guide, I'll be right more than wrong and come out ahead in the end.

Don't yet have a long-term investing plan? Sound Mind Investing can help. Learn how to become an SMI print subscriber and/or web member by clicking the sign-up button below.

Posted by Mark at 8:50 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): market correction, market volatility

Email this post

Ugly day on Wall Street

There's no good way to dress it up: yesterday was a stinker. The market is now officially in correction territory (down more than 10% from its recent highs). Not insignificantly, the market also ended yesterday below its May 6 "flash crash day" close, as well as below its 200-day moving average, which is often looked at as a determiner of the market's "major" trend (as opposed to its short-term trend).

Before we get overly pessimistic though, it's worth noting that this is the first correction in the 14 months since this bull run began. Lest anyone forget, corrections are a perfectly normal part of stock market investing — this being the 94th official correction in the S&P 500's history.

Fear has definitely exploded again. The VIX, a common measure of market volatility and fear, hit its highest level yesterday since March 2009. Sometimes fear is warranted and the market follows through on those fears. But many times, spiking fear presents great buying opportunities for those who are prepared to act while everyone else is in its grip. Remember the old saying, "Buy when there's blood in the streets."

So what does all this mean? What should you do?

That depends on you. Are you a trader, or an investor? If the latter, you need to be viewing yesterday's action through the lens of the next 5-10 years. Granted, there are no guarantees that that the market won't fall further and stay down for awhile. But that's where having a long-term plan becomes so valuable.

Having a well-thought-out long-term plan allows you to look at the events of this week as a buying opportunity. In effect, stocks are "on sale." That can be a good thing for people like me who still have a long way to go before retirement.

Of course, with the fear in the air, it would be incredibly easy to rationalize why you should wait before buying — after all, prices could fall further. But I'm comfortable investing now because I think there is reasonable possibility that a decade or two down the road, investing at today's prices will seem reasonable in hindsight.

Some of you with shorter investment time-frames than mine may have long-term plans that will prompt you to take some action right now. That's fine. Just don't make emotional decisions here. Those don't usually work out real well.

As much as possible, continue to keep looking long-term. That's an investor's perspective. Leave the short-term implications of yesterday (and today and next week) to the traders.

Don't have a long-term plan? Sound Mind Investing can help you develop one. And our core investment strategies (known as Just-the-Basics and Fund Upgrading) have a track record of beating the market — a key component of helping people reach their long-term goals.

For details on how to become an SMI print subscriber and/or web member, click the sign-up button below.

Posted by Mark at 9:20 AM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

Blissfully ignorant

In September 2008, just before all panic began to break loose in the markets and the economy, the SMI newsletter featured an article titled, Don't Look!: Blissful Ignorance Can Be Your Investing Ally. Key paragraphs:

Unless you just happen to like high levels of stress, it simply doesn't pay to follow the daily movements of your portfolio. Sure, it may seem like daily performance information is helpful, or at least not harmful. But most of us simply aren't wired to process significant swings in our investments without a commensurate swing in our emotions.

Emotional upheaval causes us to want to "do something" in response — something like "get out of the market until things settle down." Unfortunately, that kind of short-term emotional response almost always undermines the long-term appreciation of one's portfolio....

[T]he only time you really need to look at your holdings is when it's time to take a predetermined action that's based on your long-term plan, such as replacing one fund with another (as Upgraders do) or rebalancing your portfolio....

So if watching your portfolio go up and down has you all stressed out, the simple solution is to just look the other way — until your plan tells you it's time to look. When that time comes, check your holdings, take whatever action is needed (based on your plan), then get on with your life.

Chuck Jaffe at MarketWatch is offering similar advice in the wake of recent market volatility, including the early May "flash crash."

Combine too much information with too little confidence and you have a recipe for knee-jerk reactions....

"Our emotions are going to be affected by where our attention is," [said John Nofsinger, a Washington State University professor who studies investor behavior]. "And if our attention is on the minute things — the moment-by-moment or day-by-day — we will have a lot of swings. If our attention is on the big picture, we can breathe normally while the wild swings are going on."...

Experts in behavioral finance note that many investors move to [a day-by-day investing focus] as they age, as their financial recovery time shrinks and as they look out at the future and fear that maybe they will be the person whose retirement is put on hold because of one bad day....

Investors need to use events like [the May 6] meltdown to find the right "psychological distance" from the market — the range of emotions they can live with.

"You don't want to think the sky is falling all the time, but you don't want to ignore things and assume nothing can happen," [said Donald MacGregor of MacGregor-Bates Inc., a Eugene, Ore., firm that researches judgment and decision-making]. "You need to develop the emotional discipline to have a plan and stick with it, but also to recognize that market moves that didn't bother you when you were 25 might bother you a lot when you are 50 or 60."

This is why SMI's approach to investing involves carefully taking into account one's investing temperament and season of life when developing an investing plan. Doing so will help you adopt a plan you can stick with when the short-term news is unsettling.

To borrow a phrase from Ben Franklin (he used it in speaking of marriage): "Keep your eyes wide open before [investing], half-shut afterwards."

Visit our investing strategies page to learn more about investing the SMI way. For details on how to become an SMI print subscriber and/or web member, click the sign-up button below.

Posted by Joseph at 8:50 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): market volatility

Email this post

Market correction, we barely knew ye

The most common definition of a stock market "correction" is when the market declines by at least 10%. Situations like last week illustrate why common definitions can get a little tricky in practice.

Using the closing prices of the market indexes, we still have not had an official correction since the bull market began in March 2009. By that measure, the market fell just 8.4% in the recent weeks through last Thursday, May 6.

But if you use intra-day prices, from the high on April 23 to the low on Thursday, the market fell 12.6% — enough to qualify as an official correction. Given the unprecedented nature of last week's drop and the fear that accompanied it, I expect most investors will think of this as an official correction.

In recapping this "correction or not" situation, MarketWatch editor Nick Godt points out some interesting parallels between the news/market action of the past week and that of September 2008–March 2009:

If it felt in recent weeks like we were thrown back in time somewhere between the collapse of Lehman Brothers in 2008, the credit market freeze and the deep global recession that followed, it wasn't just a bad dream.

Exactly what I was thinking (I should have written it faster!). Last week's rapidly building fear about "contagion" spreading from the Greek debt crisis, the partial seizing up of the debt markets and quickly following plunge in the stock market — all of it felt very similar to the period in September–October 2008.

Thankfully, it was relatively short-lived, in part because of Monday morning's announcement that Europe had agreed on their own version of "Le TARP" — a stimulus and debt-relief package equivalent to nearly $1 trillion. How in the world they are ever going to pay for that is beyond me, but it can't help but remind us of the U.S. government's response in March 2009 when we passed our own stimulus bill and the markets roared back to life.

Make no mistake, this is merely "kicking the can down the road," much like our own stimulus package. The hope is that an organic recovery can take hold that will allow these monstrous debt commitments to be repaid over time. Whether events will play out that way remains to be seen.

While the long-term implications of this approach is unknown, it's worth noting what the U.S. financial stimulus did to the investment markets. They took off and didn't look back for a year.

That's not to say it was the right thing to do — there are more important considerations than the short-term boosting of the financial markets, and I think most of us have serious reservations about the price to be paid for all this in the future. But for the present, as investors, it would probably be foolish to ignore the potential implications of this second gush of liquidity into the system. If there's anything we've learned from the past 10-15 years, it's how responsive financial assets have tended to be to monetary stimulus and liquidity.

Some are pessimistic about the immediate impact Europe's problems are going to have on the U.S. markets. But it seems to me that this is yet another round of ammunition for a "great next 12-18 months, then watch out" scenario. Time will tell.

As always, attend to your immediate priorities (debt, savings) and don't take more risk than necessary in pursuit of your investing goals. That's one bit of certain financial instruction we can offer in these "interesting times."

Posted by Mark at 8:35 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): current market events, investing principles, market correction

Email this post

Austin Pryor returns to national radio in triumph   :-)

Well, that was interesting. Last night, I went along with son Andrew (SMI's esteemed webmaster) to visit with friend Hugh Hewitt, who was in town (Louisville, Ky.) doing his talk show for the evening. Hugh usually broadcasts from Southern California, and has (according to Talkers magazine) an audience estimated to be about 1.75+ million listeners who tune in at some point during the average week.

Hugh was in town for personal reasons, and was broadcasting from the studios of his local Salem Radio Network affiliate. The drawing card for us was not only a chance to visit with Hugh again, but to also connect with some Young Life friends who head up the YL outreaches in the UK — Tom and Ninie Hammon.

Andrew and I and our wives are friends and financial supporters of the Hammons, and always enjoy our visits to learn the latest about their efforts in England, Scotland, Ireland, and Wales. Hugh had invited them to be interviewed on his program last night.

It was really Andrew's deal, but at the last minute he invited me to tag along. Thought it would be fun to see everyone, and also be in a radio studio again. As many of you may know, I was a regular guest on Larry Burkett's call-in program throughout the 1990s, and continued on with Howard Dayton for a few years after Larry went home to heaven.

The last thing I was expecting was to be on the air, speaking off the cuff, to a national audience. But that's what happened. On something of an impulse, Hugh asked if I would be willing to do a segment and talk a little about SMI as well as the market's wild behavior yesterday. No prep time, but being the seasoned veteran that I am, I foolishly agreed.

It was fun, went by quickly, and it wasn't until this morning that I began thinking of how I might have expressed myself better. So I decided to give myself something of a "do-over" and write all about it in the upcoming June issue of the Sound Mind Investing newsletter. Look for my editorial "What I Should Have Said" (working title).

If you'd like to hear what, in fact, I did say, you can listen to that below. The first two segments contain Hugh's interview with Tom Hammon. I believe you'll find it very interesting — Hugh, Andrew, and I sure did. Then I come along in segment three. Those segments cover a total of about 25 minutes.

Posted by Austin at 4:00 PM | Comments (0) | TrackBack
Category(s): Christian Interest, Current Market Events
Tag(s): christian investing, missions, radio

Email this post

Market autopsy

There aren't many convincing answers available at this point regarding what actually caused yesterday's mini-panic, but one thing is clear regarding yesterday's crazy day: there was some serious weird stuff going on. Here's a brief recap.

First, here are the lowlights of how it unfolded:

• 2:00 p.m., Dow was down 155 points
• 2:40 p.m., down 415 points
• 2:47 p.m., down 988 points
• 2:57 p.m., down 388 points
• 4:00 p.m., down 347 points

So what happened? Investigators are poring over the details today, I'm sure. Among the oddities uncovered so far, the Wall Street Journal reports:

Multiple stocks, ranging from Accenture PLC to Boston Beer Co., momentarily lost nearly 100% of their value, changing hands for just one penny. Exchange-traded funds, which are index funds that trade like stocks on exchanges, were also temporarily vaporized. The $9.5 billion iShares Russell 1000 Value Index Fund went from $59 to around 8 cents in the blink of an eye.

At least six stocks went to zero, and at least one (Sotheby's) went from around $30 to $100,000 momentarily. Some traders report seeing others experience this kind of crazy behavior.

Most of what I'm reading this morning indicates that an errant trade — I've seen a couple reports that one Proctor & Gamble trade was entered with a billion rather than the intended million — sent the computer algorithms into a spasm.

Computer trading is the only one way I can imagine how a giant ETF trading at $59 gets executed at 8 cents a share moments later. Automated algorithms account for a huge percentage of the daily volume in the markets, and that's not all bad — it's one of the forces responsible for typically narrowing the bid/ask spread to a single penny in recent years (many of you likely remember the old fractional system when 1/8 — 12.5 cents — was the narrowest spread available).

The only problem is computers don't have "common sense" to recognize something is totally out of whack in conditions like that seven-minute window yesterday. They just keep following their rules and driving things further and further out of whack.

Expect some serious questions to be asked about these systems and how to better protect the whole market system in the future. In a way, given that things didn't melt down into total chaos yesterday, it may have been a helpful wake up call that can strengthen the system for the future.

And frankly, as scary as it is to realize the system has flaws like these, it's comforting in a way that the cause of the meltdown was likely mechanical rather than a genuine fear-based selling panic. Mechanical flaws can be addressed more easily than market psychology.

Posted by Mark at 11:45 AM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): current market events

Email this post

Panic flashback

Whew! What a wild wide today on Wall Street — apparently driven by concerns that a debt-driven contagion could take hold in Europe and spread around the world. The Dow Jones Industrial Average was down almost 1,000 points (9.2%) before recovering to a 348-point loss (3.2%).

Here's a gut-wrenching summary from the Wall Street Journal:

Stocks plummeted in a flashback to the panicked trading of 2008 as investors registered deep fears about the European debt crisis. Selling accelerated late in the day due to a wave of automated sell orders that turned an ugly drop into full-blown market washout.... The velocity of the plunge in stocks was breath-taking.

Fears of contagion from Greece's debt crisis grew during the day and stocks were lower for most of the session. But many were at a loss to explain why stocks suddenly made such a staggering move.

A near 1,000-point drop is "people jumping out of windows" territory, said Gerard Cassidy, an analyst with RBC Capital Markets.

As losses piled up, the Dow went into freefall, tumbling through 10000, before dropping as much as 998 points, or 9.2%. The biggest closing point drop in the Dow's history occured on Sept. 29, 2008, at the height of the financial crisis, when the Dow ended the day down 777.68 points, or 6.98 percent.

One observer suggested to the WSJ that photos and video of street protests in Greece played a significant role in today's market turmoil.

"To tell you the truth, people are seeing what's going on in Athens on CNBC and it's not helping the market at all," [said Joe Benanti, managing director at Rosenblatt Securities]. "You're just watching things sort of melt away."

As much as anything, this could simply be an overreaction on the part of extremely jumpy investors, following a year of huge market gains without any significant corrections. The Greece situation and potential it seems to have to spread and roil the debt markets just looks too familiar to what happened 18 months ago. Sometimes when the market has run up too far, too fast, just about anything will do as an excuse for a fall (though they aren't usually as dramatic as today).

There's another key ingredient here: fear. The old saying is that the stock market "climbs a wall of worry." Worry is out there all the time, as investor fret about this and that. But some days that worry, given the right spark, explodes into full-blown fear. The WSJ's MarketBeat blog reports the market's "fear index" (also known as the VIX) is "currently hovering around 40, a level we haven’t seen since April last year."

It's difficult to know precisely what to make of this. Most fears are unfounded — as noted in our our February 2008 cover story, The High Cost of Fear (subscriber link). Or at least things we're fearful of don't turn out nearly as bad as first assumed.

But, on the other hand, sometimes fear can help protect us from genuine threats. And, make no mistake, genuine threats are out there, as we have noted many times here on the blog and in our monthly newsletter.

The best approach is to review your long-term plan, reflect as calmly as possible on current events, and keep away from emotional decision making.

As noted in our January 2009 cover story, How to Avoid Panic and Reduce Fear (subscriber link), "[i]nvestors are biologically induced into short-term thinking by the stress hormones released during episodes of acute fear. Fear has the effect of inducing concrete short-term thinking with poor flexibility in judgment."

Remember our SMI bedrock verse: "For God has not given us the spirit of fear, but of...a sound mind" (2 Timothy 1:7).

Posted by Joseph at 4:30 PM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): investing principles, stock market

Email this post

It's a guy thing: Study finds men more likely to sell at market lows

Okay, guys. Show some backbone. Or some patience. Or stop being so overconfident.

A study from Vanguard (released late in 2009 but picked up last week in the New York Times) shows that during the market downturn of '08 and early '09, men were much more likely than women to sell their shares at stock market lows, rather than patiently waiting for a rebound.

John Ameriks, head of Vanguard Investment Counseling and Research and a co-author of the study (PDF), ascribes the disparity to male overconfidence. "There's been a lot of academic research suggesting that men think they know what they're doing, even when they really don't know what they're doing," he told the Times.

Maybe. Or perhaps guys just tend to be more impatient than women. Or maybe they're more apt to track their investments closely, and therefore more apt to respond to the short-term direction of the market.

Here's more from the Times article, "How Men's Overconfidence Hurts Them as Investors":

Staying the course and minimizing costs...are the classic characteristics of good long-term...investors. But during the financial crisis, the Vanguard study showed, men were more likely than women to trade — and to do so at the wrong times.

That fits the patterns found in path-breaking research by Brad M. Barber of the University of California, Davis, and Terrance Odean, now at the University of California, Berkeley.

In a 2001 study titled, "Boys Will Be Boys: Gender, Overconfidence and Common Stock Investment" (PDF), they analyzed the investing behavior of more than 35,000 [investors who had accounts with] a large discount brokerage firm. [The accounts were segregated into those opened by women and those opened by men.] All else being equal, men traded stocks nearly 50 percent more often than women. This added trading drove up the men's costs and lowered their returns....

Short-term financial news often amounts to little more than meaningless "noise," [Professor Barber said in a telephone interview with the Times]. Far more than women, men try to make sense out of this noise, and to no avail.

Of course, like all social science research projects, the studies mentioned above may not have taken into account all the factors that could affect outcomes. But these studies — and others that have shown correlations between testosterone and risk-taking— certainly should cause us guys to think twice before taking action.

Indeed, the best approach is to keep emotion (and, yes, testosterone) out of the investment decision-making process entirely. Either of SMI's two core strategies, Just-the-Basics and Fund Upgrading, will do just that — with positive results for both men and women.

Posted by Joseph at 10:18 AM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

Double your market-anniversary pleasure

Expect to see a deluge of stock market "anniversary" stories in the coming days. We've got not just one, but two major anniversaries: today marks the one-year anniversary of the current bull market (i.e., the market bottomed last year on March 9), and the 10-year anniversary of the 2000 market top is coming up within a week or so as well (though that one depends a little on which index you use to pick out the exact top).

Here are a couple of interesting factoids I saw yesterday perusing a few of the early versions of these stories:

Marketwatch's "Riding the Rally" tries to answer the question of what to expect in year two of a bull market. Lots of historical patterns to be found here.

During the second year, historically, stocks keep rising — though not as powerfully, said Sam Stovall, chief investment strategist at S&P Equity Research.

Small-cap and midcap stocks continue to outperform both large-caps and the S&P 500, which still do all right themselves, and higher-quality issues with stable and growing earnings trump low-quality names. Since 1949, Stovall said, small-caps have returned 22% on average in the second year of a rally, while large-caps rose 15%.

Ironically, as great as the past year has been for stocks (with the S&P up roughly 66% from the year-ago lows), that really isn't all that spectacular for first-year bull markets, at least relative to the size of the bear market that preceded it.

Stovall is upbeat about the broad U.S. market's chances for a sustained advance.

"First-year bulls tend to recover an average of 84% of what they lost in the entire bear market," he said, noting that this bull run has retraced about half of the loss. "So you could say that on a recovery basis, we have more room to go."

Moreover, since 1949 none of the 10 prior U.S. bull markets has ended in its second year — the shortest was 26 months beginning in 1966. Since 1932, the median length of a bull market has been 50 months, according to S&P. That said, between 1932 and 1947, four of the five bulls fizzled in two years or less.

CNBC is echoing the "Bull Market Survival Rate Increases After One Year" theme:

History shows that by simply passing that 12-month threshold, it will make it that much more rare for the advance to suddenly end.

The 13 bull markets since 1930 that have lasted more than a year have averaged, a total gain of 153% and a total length of 4.4 years, according to data from Bespoke Investment Group.

"Bull markets that pass the one year mark have almost always lasted two years or more," wrote Bespoke's analysts, in a note to clients on Friday. "The one bull that lasted more than a year and ended after 393 days was in 1948, and that bull only saw a gain of 24 percent, so it's nothing like the current one."

Who's responsible for this historical pattern? You are! (Or, perhaps your neighbors.)

But why is one year the magical milestone? Perhaps it is because it takes more than a year for a bull market to prove its mettle with the often stubborn and less nimble retail investor, which has sat out most of these gains in bonds. Once they are convinced, their money comes flowing in and provides at least another 12-month lift to stocks.

Of course, it could all be different this time. But the longer this advance goes on, and the more the economy steps away from the brink of what has been a brutal recession, the better the chances that this bull market holds its gains.

No, it's not all sunshine and rainbows out there. But things sure look a lot brighter than they did a year ago!

Posted by Mark at 9:10 AM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

Encouraging news for long-term investors

In January of 2009, with the market still mired deep in the clutches of the bear market, I blogged about an article that claimed stocks were farther below their long-term price trend than they had been at any time in the past 200 years. The authors concluded that stocks had gotten so far below trend that it was very likely they would "revert back towards the mean" before much longer.

It took another six agonizing weeks for that bear market to find bottom, but their claim turned out to be true. The stock market shot up roughly 70% after that.

Anybody curious what that indicator is showing today?

Me too. And thankfully, the authors recently published a new article detailing that information.

As the chart shows, despite the huge rebound in the market over the past year, stocks are still 27.9% below their 200-year trend. That's obviously not as far below as the 43.1% they reached at the market bottom last March, but still significantly below the long-term trend shown by the red line.

What does this mean exactly? Unlike a year ago, the predictive value of this over the short-term is probably relatively limited. Past experience indicates that the market can stay below (or above) trend for an extended period of time. So unfortunately, we can't really look at this and conclude that a strong rally back towards the trend line is imminent.

However, for long-term investors, the chart has an encouraging message. Simply put, the 200-year track record of the chart says that stocks are likely to produce better returns than their historical long-term average until they "catch up" to the trend line. Maybe not this year, or next, or for the next 5-10 years even. But time after time those two lines have separated and then converged, and it's likely to happen again before too long. It could take a decade, but long-term investors have time on their side.

I recognize that this is difficult to accept for many people who look at the long-term challenges facing our economy and our country. But keep in mind that all of the problems we see are already known and factored into the stock market's current valuation. The stock market is a forward-looking discounting mechanism that has all that known bad news already "baked in."

That forward-looking discounting, coupled with the tendency shown in the chart for the market to revert to the mean, causes the market to continually deliver the exact opposite of what most investors expect.

That's why (in hindsight) a time like 1999 and early 2000 can be a poor time to invest, despite the fact that the external conditions seem to look great. And it's also why hindsight may well show the current period to be a good time for long-term investors to invest, despite external conditions seeming to look poor.

Posted by Mark at 9:20 AM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

Where has all the money gone?

Citing stats from the Investment Company Institute, USA Today reports that investors withdrew a net $490 billion from money market funds during the first 10 months of 2009. Most of went — where?

If you guessed "into stock funds," you're wrong. Nearly two-thirds of the money went into bond funds.

Normally, investors chase after stocks during periods of red-hot returns, and this year has produced rip-snorting returns for many stock funds. The average stock fund has soared 27.4% this year, according to Lipper, which tracks the funds. And 36 funds have soared 100% or more in 2009.... But investors aren't chasing hot returns.

Instead, they're "chasing" the perceived safety of bonds. Plus a significant number of investors apparently are cashing out and using the money for "non-investing" purposes.

"More money is flowing out of money funds than is going into bond funds — something that's only happened twice in 26 years," says Vincent Deluard, strategist at TrimTabs.com, which tracks fund flows. "It shows how deep the recession is: They may be taking money out to pay the bills or the mortgage."

Unfortunately, the story doesn't break down — for the dollars going into bonds — just how that money is being spread among funds of different average durations. Given current low rates, short- and intermediate-term funds would seem to be the safest bond funds to be holding now. People buying into funds with long durations may be setting themselves up for a major disappointment.

Bond prices typically rally when interest rates fall and tumble when interest rates rise. The yield on the bellwether 10-year Treasury note is just 3.54%. "If rates rise, that would be bad," Deluard says.

Indeed, as we warned in the January issue of SMI, the "potential for rising inflation to hurt bond values by pushing interest rates higher is one of the more important big-picture ideas for investors to be mindful of going into the next decade."

For more on this, read Mark's recent article, Re-Evaluating the "Safe" Part of Your Portfolio.

The Wall Street Journal has also taken note of the heavy inflow into bond funds, speculating that the shift from stocks to bonds is influenced by the fact that "[b]aby boomers...are bulking up on bond funds as they approach retirement."

In November, only three of the 20 best-selling funds were diversified U.S.-stock funds (one index mutual fund, two index ETFs).

Posted by Joseph at 2:27 PM | Comments (0) | TrackBack
Category(s): Current Market Events
Tag(s): bonds, investing principles, stock market

Email this post

It's back-to-basics time

Allow me to repeat part of what I wrote in my October editorial (web membership required to access full article, sign up here):

The past two years we've been dealing with [a recession], and some seasoned observers fear the worst is far from over. They advise avoiding the stock market and building your cash stockpile. Another group believes it's likely the economy has turned the corner and the market is looking forward to a recovery. These advisers recommend moving money off the sidelines out of cash and into stocks.

There's also a third group, which is a little harder to pin down as they vary in their expectations regarding economic recovery. What unites them is their expectation that the federal government's record-breaking deficits will increasingly cast doubt as to the soundness of the U.S. dollar and its value will decrease at an ever-quickening pace. In other words, they fear that sooner or later, we'll see much higher inflation.

Even if this third group is correct, the timing is uncertain. Thus, we have a situation where it can make perfect sense to believe in either scenario #1 or #2, and at the same time also believe in scenario #3. One can be concerned about deflation in the short-term, but also be concerned about inflation coming further down the road.

This is increasingly on our minds as Mark and I think through our suggested portfolio allocations for 2010. We want to offer inflation-hedge type investment options for our readers, yet do so in a way that doesn't over-emphasize them or imply that they're essential portfolio components quite yet.

At the individual level, as readers contemplate their current stock/bond mix and whether it still makes sense given the current environment, they must continue to balance their fear of loss (perhaps heightened after the recent bear market) and their need for growth (also heightened as a result of losses in 2008).

Daniel Fisher in Forbes recently highlighted the challenges facing investors next year:

In all of 2007 the Treasury issued $237 billion in new debt (net of retirements). This year, through early October alone, it has added $1.2 trillion to its obligations. That's $4 billion a day.

With a supply like that, logic would have it that prices would fall and yields rise. Instead, since approaching 4% in June, the yield on ten-year Treasurys has fallen steadily. On Oct. 7 a big chunk of the latest offering flowed through RBS at a yield of 3.2%, down from 3.5% a few weeks earlier....

What gives? Despite worries that the government's huge deficit will cause inflation and interest rates to spike, the bond market is signaling that we have a worse problem on our hands: a dismal economy.

Low interest rates aren't particularly good for investors... With few attractive alternatives, investors are squirreling away savings in Treasurys, which is pushing prices up and yields down.... "It's a strategy for losing money safely," says Erik Davidson, senior managing director at Wells Fargo's Private Bank, which is urging clients to move money into stocks.

Perhaps investors are not fools, though. Their willingness to buy Treasurys at crummy yields rather than stocks implies the economy will shrink next year rather than grow. Despite signs of a bottoming, industrial output is at 70% of capacity, the lowest level in two decades and ten percentage points below its 36-year average. Consumer credit outstanding, at $2.5 trillion, was off 6.5% in September from a year earlier and has now contracted for the longest period since the early 1990s. Unemployment is still going up.

The unwinding of the credit bubble is not over. U.S. banks have barely begun to digest their commercial real estate problems. A bolus of $600 billion in commercial mortgage-backed securities issued between 2005 and 2007 is likely to begin defaulting in earnest next year. All this could mean more economic weakness and a double-dip recession. In that case stocks are no bargain now.

Since none of us knows what 2010 holds for the economy or our investments, it's a good time to redouble our commitment to following biblical principles as we make money management decisions — get (and stay) debt free, build a contingency fund for the unexpected, and diversify our portfolios across a range of investments that march to different drummers.

Next year is shaping up as a time for caution, not investing heroics.

Posted by Matthew at 11:34 AM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

Setting the record straight on the Crash of '29

On this 80th anniversary of the Great Stock Market Crash of 1929, I refer you to Mark's February 2008 article that corrects common misconceptions about the crash.

As he noted then, "Sadly, because these misconceptions are foisted regularly upon the investing public, many investors fear bear markets intensely and make poor decisions as a result."

Read The Truth About the Crash of 1929.

Posted by Joseph at 10:50 AM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

Don't fight the Fed

The first stock market saying I ever remember learning was "Don't fight the Fed." The professor in my first college investments course was explaining the importance of the Federal Reserve's monetary policy decisions on the stock market's direction. He walked us through some prominent patterns (each with it's own pithy saying) like "three steps and a stumble" — the tendency for the market to fall after the Fed raises interest rates for a third consecutive time — and why those relationships existed. Some of these specific patterns aren't as widely known anymore (perhaps because the Fed started changing its Fed Funds interest rate more often over the past two decades?). But the main idea was that if you wanted to succeed in the stock market, you had to know what the Fed was doing and position yourself accordingly.

This came to mind today while reading Jon Markman's latest article. In it, he describes the impact that he expects the massive stimulus efforts of the US government (along with virtually every other world government) to have on the stock market. In his view, this massive unloading of the monetary cannons trumps every other factor when evaluating the likely direction of stocks for the next few years. His opinion is we're witnessing a replay of 1991. Terrible economy, significant financial duress (S&L crisis), and the birthing of a massive bull market in equities. In other words, don't fight the Fed.

Picture this: At least $10 trillion has been created and poured into the world's financial arteries in a process that will take at least three years to seep out through various government spending programs. And if bearish skeptics don't understand the impact that money will have, it's mostly because they've never seen something that big before and it's frankly almost unimaginable. "People don't see it because monetary infusion cycles don't happen very often, and certainly not on this scale," [veteran money manager Robert] Drach said. ...

"The main thing is not to be frightened of the market," Drach said. "People who get hurt will be ravaged by low returns in Treasurys. They will be annihilated. It will look to them as if the whole episode is a money-transfer system from senior citizens and foreign investors buying U.S. government bonds to young people buying stocks. But it won't have to be that way for anyone. Everyone should participate in equities if they can. It will be a rare opportunity to grow wealth."

So get ready to party like it's 1991. If sector rotation becomes key, then the game will be played at the level where we must figure out which groups are faltering and which ones are about to take their place.

It's an interesting premise, and worth a quick read of the whole thing to see how he draws the parallels between the early 90s and today.

Is it plausible? Hard to know. But it is surprising to me that so few people seem to have focused on the potentially positive implications this huge wave of liquidity has for the market. Those that mention it at all seem to view it in exclusively negative terms, as in "this market rebound has been artificially inflated by all the stimulus...just wait until that runs out and the market crashes again."

Ultimately, the insane borrowing and spending the government is doing has to come home to roost, or else the government would just do this every time the market needed a boost (some would argue that's pretty much exactly has happened during the past 25 years). But the timing of those cause-and-effect relationships can be much more protracted than anyone would expect.

A final thought: if this does turn out to be remotely accurate, note the last comment I excerpted above. "If sector rotation becomes key, then the game will be played at the level where we must figure out which groups are faltering and which ones are about to take their place." That's a pretty good explanation of what SMI's Upgrading strategy does. Good to know we'll be well prepared...

Posted by Mark at 5:06 PM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

MMF guarantee program ends

On September 16, 2008 the Reserve Primary Fund "broke the buck" and closed the day with a value of less than $1 per share, a huge no-no for money market funds. Over the next two days, 22% of all assets in institutional prime money-market funds were pulled by investors, and overall roughly 7% of all assets held by the money-market fund industry were redeemed during those 48 hours. It was, as we've referred to it here recently, a largely invisible (because it mostly happened electronically) — but still very real — modern day run on the banking system.

As a response to this rapidly developing crisis, the federal government stepped in on September 19 and guaranteed all money market fund deposits, subject to some modest restrictions. That largely stopped the panic.

A year has now passed since that program was put in place, and the Treasury Department has decided the system is healthy enough now to let the guarantee program expire.

While that's certainly a good thing — both in terms of the crisis dying down to where it's no longer necessary and the general principle of getting the government out of the normal functioning of the markets — it does make me wonder how much of a lingering presence these programs will have going forward. Specifically, while the government backstop is being formally eliminated today, is there any real question what would happen if the same conditions emerged again next month, or next year? Does that implicit guarantee make market participants behave differently than they would have before? I'd have to think it does.

Solving that problem is going to be a difficult task, for sure.

Posted by Mark at 3:37 PM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

A year ago today...

Today marks the unhappy anniversary of the slide into financial panic. While the financial landscape may not be in great shape today, I think most would agree that things could be a whole lot worse. In fact, I'd guess that if we had taken a reader survey 50 weeks ago, many/most probably would have expected conditions to be worse today than they actually are.

Going into last September 15, conditions had been rocky for a while, and obviously the big-picture issues (like falling housing prices, bad subprime debt, leverage and derivatives) had been festering for quite some time. But it was the government's decision to allow Lehman Brothers to file for bankruptcy a year ago today that marked the turning of the corner into a full-fledged financial panic. In the few days that followed, AIG would be taken over by the government, Merrill Lynch would be forcibly folded into Bank of America, and a money market fund breaking the buck would start an invisible, but very real, run on the banking system. (It's also pretty easy to make at least a reasonable argument that the Presidential election turned on the events of that fateful day/week as well.)

We've talked about many of these events and their implications over the past year, and while part of me would like to stop and revisit them, we've got a newsletter deadline staring at us at the end of this week. So our energies are required elsewhere for the next few days.

Still, I couldn't let the anniversary of this momentous shift in the financial system pass without a word. There are so many lessons to tease out of the events of the past year, but one stands out from the rest in my view. And that is simply the importance of investing with a long-term plan in mind.

If ever a case could have been made for chucking your long-term plan and reacting in the face of seemingly game-changing events, it would have been so this past year. And in fact, for the next several months after last September 15, staying the course looked like a decidedly bad move. But as we kept reminding readers, the key question wasn't where would stock prices be in a month, but where would they be in five to ten years?

Six months after last September, when stocks were bottoming in early March, it was hard to believe they could recover even within that time frame. Yet here we are, a year later, and our losses no longer look insurmountable. While the market itself is still off by double digits, Upgraders who stayed the course through thick and thin are back to "mild loss" levels. Morningstar shows the SMI Fund (SMIFX), which is also a useful proxy for newsletter upgrading, down just -7.30% over the past year (through last night's close; note the performance reported at this Morningstar page changes daily). Morningstar shows the more conservatively-run SMI Managed Volatility fund (SMIVX) down just -6.69% over the past year, with significantly less volatility along the way.

If an investor didn't know how those particular 6.7%-7.3% losses were realized, they likely wouldn't even blink at one-year losses in that range.

And that's exactly the point. Losses like we saw last winter can materialize faster and cut further than anyone expects. And rallies like we've experienced the past six months can do the same thing, just in the opposite direction. Trying to time those moves is an exceedingly difficult exercise. Just ask the countless investors today with money sitting on the sidelines that was pulled out of stocks at some point during the past year.

It's been a wild ride for investors, enough to reveal to some investors that they really can't stomach the level of stock market exposure they had previously planned on. That's a reasonable lesson to take away from the events of the past year. With our losses back to levels that no longer seem so threatening, it's worth revisiting the events and accompanying emotions of the past year, in an effort to learn how we can better prepare for and handle future periods of extreme market volatility.

An SMI subscription or web membership can help you work through that process and emerge with a rock-solid long-term investing plan in place. To take the first step of that journey, sign up today.

Posted by Mark at 2:48 PM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

Weak recovery = strong stock gains?

According to columnist Jon Markman, up is down and down is up:

Investors who are worried that the economy won't advance fast enough or far enough to justify a 15% rise in the stock market this year have it all wrong. Stocks have actually been rising because the coming recovery from last year's wipeout is expected to be slow and weak, rather than fast and furious.

If that seems backwards to you, I encourage you to read his full explanation. In a nutshell, he argues that corporate earnings and global economic growth aren't the primary market movers over the short term. Instead, interest rates, inflation, and sentiment are the keys, with government policy also playing an important role. When those factors align as they have, and continue to, the market can advance much faster and further than most expect, even in the face of a sluggish economic recovery.

Because the economic recovery continues to be so tepid, Markman thinks the market could stay in this "sweet spot" for some time yet. Quoting from another article he wrote recently:

Every time that a 12-month-average buy signal has been given after a bear market of a year or more, the ensuing up move has itself lasted at least a year — and more often three or four.

The primary reason: The government and central bank response to a calamity like the Lehman Bros. collapse and panic is typically so powerful and over the top that the monetary infusion cycle — fiscal stimulus and superlow interest rates — that ensues is much more persistent than anyone expects.

Perma-bull? Hardly. Unrealistic stock promoter? I don't think so. Markman actually believes we're in a secular bear market — have been for almost 10 years now. But within that long-term bear market, he says we should continue to expect big cycles. 2000-2002 was a big bearish cycle, followed by the 2003-2007 bullish cycle. We had a huge bearish move over the next 18 months, and now he thinks we're primed for another significant leg up, much more significant than most are allowing for.

And he thinks the very fact that many investors are having so much trouble accepting that possibility makes it that much more likely to happen. Bull markets love to climb a wall of worry, and there's plenty of worry still out there to climb. Read his full article(s) and see what you think.

Posted by Austin at 3:59 PM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

September is here — should you be nervous?

We're just two days into September, but already two mutually-reinforcing things have happened:

1. A plethora of "September is the worst month for the market" news items have been generated; and
2. The market took a dive on the first day of the month, as if to announce its arrival!

Here's the background: September does in fact have a well-earned reputation as the worst month for the stock market.

And it's not just the long-term averages providing reason to get antsy. Some would wonder if the long-term averages are skewed by a handful of really bad years. If so, that would seem to imply that maybe years when stocks are rallying are immune to this mysterious September effect, right?

Wrong. As this article points out, years when stocks were up year-to-date, up from June-August, and up in August by itself actually produced worse than usual Septembers. In fact, September saw losses in all but 3 of the 17 instances that met that "markets have been rallying" description (though in fairness, the average September loss was just 1.73%, hardly devastating).

What's behind this September trend? No one really has put forth a compelling explanation as to why stocks tend to struggle so much in September. One plausible explanation has to do with institutional investors selling in order to take losses before their year-ends, most of which occur either Sept 30 or Oct 31.

Others argue that as the pattern has become more widely known, it has become something of a self-fulfilling prophecy.

While stocks have tended to perform poorly in Septembers past, another market has fared very well in that month: Gold. In fact, over the past two decades, September has been the strongest month for gold, rising an average of 3.4% for the month and finishing with gains in 16 of the past 20 years.

What should you make of all this? Probably very little. Valid historical pattern or not, the losses we suffered yesterday on Sept 1 already exceed the average loss for past Septembers. So you could just as easily argue that on average, we should expect the rest of the month to be flat to slightly positive.

Better yet, don't sweat what's likely to happen over the next four weeks. Keep your investment gaze appropriately fixed on the distant horizon (at least five years). When you do that, the performance of the next 30 days looks like a tiny blip.

If anything, those who have been surprised at the rally's strength might look to any September weakness as a potential buying opportunity. The market has been going up for six months now without experiencing any type of significant pullback. Market sentiment has gotten quite bullish. Several factors seem to be aligned for a pause or pullback.

So if you've had money on the sidelines that you've been itching to get back into the market as you watched this rally go up, up, and away, September could well provide a decent entry point. If that's you, thinking through what that looks like in advance will help you be more likely to actually pull the trigger should the opportunity present itself.

For everyone else, sit tight and don't get spooked by all the "September is bad for the markets" hype blowing around this week. It is in statistical terms. But the reality is that these average losses for the month are pretty small numbers — smaller than what we've already had delivered in the first two days of the month. So stick with your plan and ignore the headlines. Maybe this September the market will be up, maybe it'll be down, but five years from now you're not likely to remember one way or the other.

Posted by Mark at 5:06 PM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

The new kid on the block in the municipal-bond market

Tucked in among the 400-plus pages of the "stimulus" act passed earlier this year (see Part V, Sec. 1531) is the authorization for Build America Bonds, a new kind of taxable municipal bond subsidized by the federal government. (Right now, the authorization is for 2009 and 2010 only.)

Billions of dollars worth these bonds have already been issued and, due to the subsidy, most are paying higher interest than traditional municipal bonds. Although that interest may be free from state and local taxation, the bondholder must pay federal tax (that's not the case with traditional munis).

The higher interest may be attractive, but a primer on Build America Bonds issued by the Securities Industry and Financial Markets Association suggests that BABs aren't really appropriate for most individual investors.

Individual investors who might be considering these bonds should understand that Build America Bonds are new and complex instruments, are not conventional municipal bonds and are not as liquid as municipal bonds. These bonds might be considered for part of an individual investor's buy and hold strategy if they hold bonds for maturities of 20 years and longer....

Individual investors should consult their financial or investment advisors for more information to determine whether these investments are appropriate for their particular circumstances.

Is there a mutual fund that invests strictly in Build America Bonds? No, not so far.

BABs have had a strong showing since their introduction just a few months ago, with more than $17 billion worth already sold, according to Bloomberg. Texas, California, and New Jersey had issued more than $1 billion each, as of June 30.

Taking a larger view of the municipal-bond landscape, George Mason University professor John E. Petersen thinks BABs have the potential to ultimately kill the traditional tax-exempt bond market. He explains why in a recent article in Governing magazine.

Posted by Joseph at 4:57 PM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

Another bullish indicator

Earlier this week, the Dow gave another bullish signal that the bear market may be over. Or at the very least, that it will be a while before it resumes.

Bloomberg reports on this signal:

The Dow Jones Industrial Average is sending a buy signal that has foreshadowed gains of 18 percent during the past nine decades.

The 30-stock gauge climbed to more than 10 percent above its mean level from the previous 200 days, rebounding from 34 percent below the so-called 200-day moving average in November, according to data compiled by Bloomberg. Eighteen of the last 21 times the Dow rallied from at least 10 percent below the 200-day level to 10 percent above, it posted gains during the next 12 months, Bloomberg data since 1921 show.

Take a moment to look at the table contained in the article linked to above. It shows each of the 21 times this event has happened since 1921, nearly all of which occurred during or near the end of bear markets. Of the three times when the market was not higher a year later, it was less than 4% lower twice (i.e., very minimal losses in the year following the signal). Only once in 21 instances was the market substantially lower (-16.61%) a year after this signal.

For reference, a loss of 16.61% from today's levels would drop the S&P 500 from it's current level of ~989 down to roughly 824. It bottomed at 666 in March. So if the worst of the 21 instances from nearly the past century were to recur, the market would give back roughly half of the gains we've experienced since March. I think that's a dramatically more optimistic "worst case scenario" than most investors are harboring in their minds currently.

(I need to hasten to add that there are no guarantees with the stock market, and certainly none should be implied from my statement above about worst-case scenarios. I'm simply talking about the past record of this particular indicator — obviously the true worst-case scenario is potentially much worse than what this indicator has ever experienced before.)

It's probably also worth pointing out that in all three of the prior worst bear markets of the past century (1929, 1974, 2000), the ultimate bottom was already in place before this indicator triggered. One more reason to think the worst may be behind us.

Pursuing a similar line of thought, Jason Goepfert of sentimentrader.com published a study last week that looked at how long it took the market to fall back below the 200-day moving average after moving 10% above it, as just occurred this week. His study showed that on average, since 1932, it took the market nine months to fall back below the 200 dma. Even more interesting, it showed that the worst-case example took five months to fall back to the 200 dma.

That probably requires a little translating. The 200-day moving average takes roughly 40 weeks of data and averages it, so it isn't very quick to change. So what the paragraph above is saying is that five months is the fastest the market has ever dropped roughly 10% once it got this far above the 200 dma. That's a rough paraphrase, but pretty close to accurate. Five months takes us through the end of 2009.

Again, I think if you asked what the likelihood was that the market would drop 10% from today's levels at some point between now and the end of the year, many investors would answer the likelihood is pretty high. This study is saying that isn't the case, that since 1932 that has never happened in the time frame that would take us through year-end. Kind of surprising, frankly.

Once again, there's no guarantee with this indicator either. Just because it hasn't happened in the past 75 years doesn't mean it couldn't happen this time.

The reason for posting information like this is that there's a very natural tendency to be fearful following severe bear markets. This response causes most investors to miss out on a significant portion of the next bull market. Eventually, the market rallies so far from the prior lows that investors get comfortable that the last bear market really is over. Just in time to get back in near the highs and get trampled all over again.

That's why SMI tends to focus so much attention on purely mechanical signals, like the all-clear indicator, that can give us a stiff shove when we're reluctant to get back in the market after a big loss. We trust those historical indicators more than our own gut/intuition/reason after a big bear market, simply because we know that our emotions will continue to lie to us long after the worst is past.

I'm not saying you should throw caution to the wind. I'm definitely not saying you should take more risk than your plan requires in order for you to meet your long-term goals. But I am saying that it's time to start moving back towards the allocations your long-term plan calls for if you're significantly below those levels. And at a minimum, start giving at least as much consideration to bullish indicators like these and the all-clear signal as you are to any bearish information you're receiving.

The market has gained 4.4% since the all-clear indicator was triggered seven weeks ago. That may not seem like much, but it's an annualized rate of over 37%. For those still waiting on the sidelines, at the very least you need to answer the question, "What needs to happen for me to get back into the stock market?"

Posted by Mark at 2:53 PM | Comments (0) | TrackBack
Category(s): Current Market Events

Email this post

There's good news, and there's bad news

The good news is the index of leading economic indicators is signaling that the recession is nearing its end:

The index of leading indicators, which signals turning points in the economy, is rising at a rate that has accurately indicated the end of every recession since the index began to be compiled in 1959.

The index was reported this week to have risen for the third consecutive month in June, and to have risen at a 12.8 percent annual rate over those three months. Such a rise, pointed out Harm Bandholz, an economist with UniCredit Group, “has always marked the end of the contraction.”

Mr. Bandholz said he expected that the National Bureau of Economic Research, the official arbiter of American economic cycles, would eventually conclude that the recession bottomed out in August or September of this year.

The bad news? An end to the recession doesn't mean a healthy expansion is waiting around the corner. In fact, there are a number of reasons why a strong recovery is unlikely. This well-written piece by John Mauldin David Rosenberg explains them each in detail, but the short-list includes the likely absence of consumer spending (normally a driver of expansion), a still-ailing financial sector, revenues that continue to come in way behind those of a year ago (even if improving on the even-worse rates of the past two quarters), and a giant hole to fill on the jobs front.

Perhaps not surprisingly, then, Jeremy Grantham now says the market is trading at a Boring Fair Price.

Posted by Mark at 4:10 PM | Comments (0)
Category(s): Current Market Events, Economy

Email this post

Speculative rally

In the August Level 4 report card, I wrote that "skeptics have pointed out that the biggest gains in the recent rally came from lower quality stocks, with the market running out of steam before those gains could extend to the rest of the market."

The last part of that assertion is obviously still being decided, as last week's strong performance helps give renewed faith to the bullish that the market rally hasn't yet run out of steam.

But what did I mean by that "lower quality stocks" term in the first place? That was a classic case where I wanted to provide a little more detail there when writing the article, but (1) didn't have space, and (2) didn't want to pull readers off topic delving into that side story.

Thankfully, we have the weblog, where I can circle back around to explain. Or better yet, just point you to these stats from Barron's Trader column (hat tip: The Big Picture) which make the point I was referring to:

HERE’S A SNAPSHOT OF JULY’S ROMP, courtesy of Bespoke Investment Group: From their July 10 low, the 50 smallest stocks in the S&P 500 had rebounded 17.2% through Thursday, outgunning the 50 biggest stocks’ 9.7% gain. The 50 most heavily shorted stocks have jumped 17.6%, versus just 8.8% for the 50 least-shorted names. Companies raking in foreign revenues outran domestic earners, a sign that traders are still uneasy about the dollar.

Besides short-covering, there are also ample signs of bargain-hunting and risk-guzzling. The 50 stocks with the lowest price/earnings ratios jumped 18.4%, the best performance of any decile. The 50 stocks with the worst analyst ratings are up 12.7%, versus 8.9% for the most beloved companies. And the 50 stocks that fell the furthest during the June correction have bounced back most resoundingly, their 17.4% rise trumping the 7.4% for the correction’s top performers.

Now, I should clearly note that it's very common for more speculative stocks to rally early like this, as they are usually the stocks that took the worst of the drubbing in the prior bear market collapse. So this observation doesn't discredit the rally we've witnessed since March. The key is that at some point, the rally needs to shift to include the "higher quality" stocks as well. That's what had been lacking, but is back on the table as a possibility since the market started acting perky again last week.

Posted by Mark at 4:17 PM | Comments (0)
Category(s): Current Market Events

Email this post

Politics and the SMI Weblog

Over the past several months (and culminating in the comments of a post a few days ago), there has been some feedback from a handful of readers that they would prefer we "stick to investing" with our weblog posts and steer clear of the political issues of the day.

Believe me, we'd like nothing better than to be able to do that.

If you go back and peruse the history of the SMI weblog, you'll find very few politically-oriented posts from the weblog's inception in May 2003 until about a year ago. We purposely ignored most political material, wanting to keep our blog focused on investing issues.

However, with the events of last fall and the unprecedented government responses, the lines between investing topics and political topics began to blur. It's our opinion that, due to the magnitude of the political issues currently in play, we can't responsibly cover what you need to know about investing without also covering what's going on with the political landscape.

Today, we're not witnessing politics as usual (which we used to be content to mostly ignore, figuring you'd pick up your political info elsewhere). These are potential game-changers. If you want to know how to invest now and in the future, you'd better know what's going on with these major issues.

Some have pointed out that what they don't like is when we talk about these political issues without offering specific investment advice tied to that commentary. (Although others request that we keep political posts completely separate from any investment advice; it's hard to please everybody all the time.)

The problem with that is these are evolving issues that we largely try to cover in real-time. We aren't going to try to flesh out the full investment implications of every single twist and turn of the health-care or cap-and-trade legislation, nor are we going to necessarily try to cover every angle whenever we want to delve into a specific principle or the background of an issue. This is a blog, one of the advantages of which is that it allows us to sometimes hit things briefly, sometimes share a link without much commentary, while other times writing long in-depth posts on a given topic. We're not going to give up that flexibility by agreeing to always attach specific investment advice to every post.

However, that said, it's not as though we are just lobbing political grenades and not getting around to the investment implications. You haven't seen it yet (but will within just a couple days), but we've got a very in-depth cover article coming your way this month with an extremely practical investment focus. In fact, it's so detailed we had to split it into two-parts (a rarity for SMI cover articles) so we can do justice to the implementation part of the issue. These two cover articles follow the pair that Austin and I wrote in April and May that also dealt with the investing implications of the recent shifts in government policy.

In other words, once these next two cover articles are out, four cover articles in a six-month span will have been written specifically regarding how to best position your investments given the huge changes going on in the political/economic/investment climate. Obviously we think it's important.

Now you could just read those cover articles and get the "big picture." But we know there are many SMI readers who want all of "the backstory." That's where the weblog posts on these various topics come in.

To sum up then, I want to assure any readers who are tired of the political topics in the weblog that frankly we're tired of them too. We'd like to quit writing so much about them. But until we feel like we can separate the investing world from the political world again (as we've been more easily able to do in the past), we feel obliged to continue to cover these issues and stories. Rest assured, we rarely break huge new investing advice in these types of posts, so you can skim them if you're not interested in all the details, or if you have the time to get your political news elsewhere.

We do try to be fair with our treatment of these issues. While we tend to lean pretty conservative, hopefully we've been able to stay respectful of other points of view and keep the discussion on a pretty high level. We ask that commenters follow that example in posting comments.

Changing times sometimes require changing approaches, in investing as well as in our approach to the weblog. Our preference would be to ignore the political and focus solely on the investment world. Unfortunately, that's not an option right now, as the two are overlapping to a great degree.

Posted by Mark at 1:27 PM | Comments (0)
Category(s): About Our Weblog, Current Market Events

Email this post

The Empire Strikes Back

I'm back in the office today after a week of vacation, and haven't had time to think any particularly deep thoughts yet since my return. As such, I'll wade gently back into the blogging waters by pointing you to this funny edited version of the battle between Congress and the Fed.

Posted by Mark at 4:12 PM | Comments (0)
Category(s): Current Market Events

Email this post

July 4th Kentucky "Tea Party" recap

We can't get enough of finances around here. So rather than grilling out and shooting off fireworks, I attended my second Tea Party of the year (the first one was April 15th).

In case you're not aware of these protests or their purpose, here's a relatively objective description from Wikipedia:

The Tea Party protests are a series of locally organized protests across the United States, beginning in 2009, most of which have developed into nationally coordinated events. The events are in protest of President Obama, the federal budget and, more specifically, the stimulus package, which the protesters perceive as examples of wasteful government spending and unnecessary government growth. They oppose the increase in the national debt as well. The protesters also objected to possible future tax increases, with taxes on capital gains, estate taxes, federal income taxes, and cigarette taxes. Many of the protests were held on April 15, 2009 to coincide with the annual U.S. deadline for submitting tax returns, known as Tax Day.

I blogged live on Twitter, and here's a recap for our blog readers.

This Tea Party was in Kentucky's capital city, Frankfort, on the steps of the capitol. It was one of more than 1,400 such protests reportedly being held on July 4th across the nation. In spite of the sporadic rain, I'm guessing between 1,000-2,000 had gathered, The rally started with prayer and worship music. This seemed a bit unusual to me, I must confess. On one hand, it was wonderful to be so public about our faith, but the slow music initially zapped the energy.

Things livened a bit when the speeches started. A collection of politicians, pastors, and lobbyists from across the state spoke on everything from our overreaching government to school choice to gun control, even industrial hemp farming. But most of the cheers (and boos) came from one-liners concerning increased taxes and proposed energy bills.

And speaking of the crowds, there was a typical array of signs and t-shirts, ranging from anti-socialism to lower-our-taxes and, not surprisingly, plenty of anti-Obama sentiments. My favorite sign was being held by a child: "Mortgaging my future doesn't stimulate me."

All in all, the crowd was mild and respectful. In fact, I brought a friend who'd never been to such a gathering. His oft-repeated observation, "This is crazy. Everyone's so... normal." Mainstream media would have you believe that these rallies were filled with whacked-out right-wing extremists. Truth is they're filled with normal, everyday working folk who want to voice their displeasure with how the government is spending money it doesn't have (and the anticipated tax increases to pay for it all).

So two hours and some nice one-liners later (like "Our rights aren't inherited, they're defended"), the protest was over. I was glad the rain mostly held off, glad I attended, and glad to make my voice known. But mostly, I was just glad to live in a country where protesters can gather peacefully thanks to God's provision and the sacrifices of men and women who have fought to keep our country free for 233 years... and counting.

Posted by Matthew at 3:10 PM | Comments (0)
Category(s): Current Market Events, Taxes

Email this post

Even playing field?

If you read as much financial "stuff" as we do here at SMI, you quickly learn that writers in certain quarters are convinced the financial markets are rigged. Either the government is running the show, or some group of elites, or well, somebody is clearly up to something. While occasionally some good points are raised, the argument tends to get tired (and generally speaking, as a result, we don't continue to do much reading from those conspiracy-minded sources).

While it's hard for me to believe the whole system is rigged, I don't doubt for a minute there are isolated cases of misconduct. There's simply too much money involved, and greed too hardwired into the human DNA, for there not to be. This is an area where government has a perfectly legitimate and appropriate role to play as regulator and enforcer of the laws on the books.

The question is, are they fulfilling that role? Evidence like this suggests they are not. Huge purchases of index futures in advance of the public release of government information (that is likely to move markets) needs to be met with a swift and brutal slap from the enforcement arm that oversees these types of securities transactions. Hopefully that action is coming.

It's crucial that the players in the system be held to account when they break the rules. When individuals feel like the game is unfairly stacked against them, the whole system crumbles.

Posted by Mark at 2:26 PM | Comments (0)
Category(s): Current Market Events

Email this post

Maximizing income from CD's

James Stewart of SmartMoney has a counterintuitive strategy for investing in CD's (certificates of deposit, not the musical variety). Instead of buying longer maturities in order to get slightly better yields, he thinks savers should currently be shortening their maturities.

In this environment, I have a suggestion that bucks the conventional wisdom: Instead of lengthening maturities, shorten them. You don’t have to give up all that much income; you don’t have to worry about rising interest rates eroding your principal; and the short maturities guarantee that, in the event CD rates do rise, you’ll be in a position to take advantage of them when your CDs mature.

Given the modest improvements in yield from a one-year CD to a two-year (his article quotes national averages of 2.1% for one-year and just 2.3% for two-years), I think he's right. You might give up a tiny bit of income, but chances seem good that sometime within two years you'll make that up by being able to roll-over into higher yielding CDs.

Posted by Mark at 4:32 PM | Comments (0)
Category(s): Current Market Events, Retirement

Email this post

The 'mountain of cash' on the sidelines

The Los Angeles Times' Money & Co. blog examines whether money sitting on the sidelines in money market funds will flow back into stock funds, helping to fuel an extended bull run.

The conventional wisdom, backed by historical research, says it will.

In a research report on Monday, Jack Ablin, chief investment officer at Harris Private Bank in Chicago, said that whenever money market assets have exceeded 25% of the capitalization of the Standard & Poor’s 500 index, stocks have rallied over the following two years. That number currently is 43% after having peaked at 58% in mid-December.

But the conventional wisdom isn't altogether correct, argues MMF guru Peter Crane.

[M]uch of the cash flow into money funds over the past two years had little to do with the collapsing stock market, said Peter Crane, chief executive of research firm Crane Data.

Corporations, which account for two-thirds of money-fund assets, have built up funds for purposes ranging from emergency reserves to bankrolling mergers, and are unlikely to put that cash into stocks, Crane said.

That’s a big reason why overall money-fund assets are down only 4% from their mid-January peak despite the torrid market rally since early March....

So-called retail money funds — those used by individual investors as opposed to institutional investors — have been losing assets at a faster clip this year. Retail fund assets are down 8.2% from their January peak.

But the build-up of cash in those funds in 2008 was due in part to dissatisfaction with fixed-income investments that went awry, such as exploding auction-rate securities and some surprisingly risky short-term bond funds, Crane said. So some of that money now may be heading back into other income-oriented investments — including corporate-bond funds, which have seen hefty inflows this year, and bank accounts — rather than into stocks

This is likely a case in which both side are correct. Quoting SEC info, Forbes notes that $4 trillion is sitting in money market funds. Surely, some of that money will flow into stock funds and some won't (and, as Peter Crane points out, not just because investors are skittish).

The market is made up of millions of players, each making decisions based on unique circumstances and available information. Speculating about what all those other people might do is less helpful than knowing what you're doing and why.

Posted by Joseph at 3:15 PM | Comments (0)
Category(s): Current Market Events

Email this post

What the credit markets are telling stock investors

Over the past week we've been discussing the fact that SMI's All-Clear Indicator is getting set to trigger. Re-entering the market based on this signal has been a very astute move every time it has occurred in the past 50 years or so. But many readers are understandably having a very difficult time reconciling the stock market's recent rise — much less the prospects of a continued bull market — with the continuing economic difficulties (and longer-term systemic problems).

We've looked at this from multiple angles, but one that we haven't considered at all is fleshed out by Jon Markman in this very interesting article. The basic summary is this: the credit markets led us into this mess, and the credit markets are now signalling that it's over. It's worth a quick read.

Posted by Mark at 10:43 AM | Comments (0)
Category(s): Current Market Events

Email this post

Finding value in the current market

If you're having trouble reconciling the idea of short-term opportunity in the stock market with the many big-picture issues still facing the economy, you're not the only one.

I'm a fan of author Jason Zweig (who wrote the book we excerpted our Feb 2008 — The High Cost of Fear — cover article from). He's usually pretty insightful. His recent article titled Wall Street's Clearance Sale Leaves Few Bargains details how so far in this market rally, the junky stocks are the ones that have risen the most, while the high-quality stocks haven't done as well. The tone is pretty pessimistic, wondering "But after this big and fast a bounce, how much upside can be left?"

Interestingly, he then turns to Jeremy Grantham to answer that question. (You'll recall that we've talked a fair amount about Grantham's views on the market recently.) Again, the context is basically this: the market has rallied a huge amount, the stocks that have rallied the most aren't really very good companies, and any good values that did exist seem to be pretty much gone now.

So where can a value-conscious investor turn?

Mr. Grantham regards "high-quality blue chips" as the only bastion of value in today's market. He cites companies like Coca-Cola, Johnson & Johnson, Procter & Gamble, Wal-Mart Stores and Microsoft as offering "high, stable returns with very little debt."

Dividends average better than 3% for this group; if "everything merely returns to normal" over the next few years, Mr. Grantham expects these blue chips to be able to return 11% to 12% annually after inflation.

That's the punchline of this relatively pessimistic article?

Think about this with me for a second. Here's another way to rephrase that calculation: If everything "merely returns to normal", these bluest of blue chips would be expected to gain roughly 50% over the next three years. (Assuming a modest 3% annual inflation.)

Hello? Anybody out there NOT interested in an additional 50% gain over the next three years or so? Anyone think that isn't a big enough prize to be worth playing for?

Now granted, Grantham may be all wet and the exact opposite could happen. The point really isn't to debate his view of how this is going to play out. I was just struck by the dissonance between the article's tone and the example cited. I think it's an illustration that the author, like most of the rest of us, probably feels torn about this market. Conditions obviously aren't that great, yet there still seems to be opportunity in stocks.

It's hard to reconcile. But then again, it always is during/after bear markets.

Posted by Mark at 2:55 PM | Comments (0)
Category(s): Current Market Events

Email this post

Coppock curve turns positive

I saw several references this week to the fact that the Coppock curve turned positive last Monday (or the prior Friday, depending who was reporting it). I don't ever remember mentioning this old technical indicator before in SMI, but thought some of you might have seen/heard similar reports this week, so I thought I'd touch on it briefly here.

First, here's an explanation of what the Coppock curve is and why it might matter from Don Hays:

It was developed almost 60 years ago, and when I got started in this business about 40 years ago I subscribed to Edwin Coppock’s market letter. It is most definitely a lagging indicator, and long-term in nature. It theoretically only uses month-end data, and uses a combination of two long-term momentum calculations for the "market." If you have followed it, you know that virtually every major bull market of the past 90 years has been identified by the Coppock momentum gauge turning upward and moving through the zero line. There have been a few false signals, in 1938, 1941, 1947 and 2001. The latest failure in 2001 came in that rally after the 9/11 disaster, but was the first false signal in the last 50 years. The last signal given in April of 2003 proved to be another good example of its typical "correct" call. As noted in the summary, as of yesterday — or in fact Friday's action, the Coppock Momentum formula has once again given its confirmation that this is a new bull market.

So, in a nutshell, it's another slow indicator that tries to signal when the trend has definitively changed. In that sense, it's similar to SMI's All-Clear indicator.

A lot of people got excited about seeing this indicator flip, mainly because it has a pretty spectacular record over the past 50 years or so. (Hays had a chart in their report today showing each of the signals plotted on an S&P 500 chart. I wish I could reproduce that here, but suffice it to say, after virtually every significant downturn since 1965, there was a Coppock buy signal sitting almost exactly where you would have wanted to buy.)

But not everyone is convinced. Mark Hulbert looked at the signal's record over a much longer time period and found it unconvincing. One big reason for that — it flashed two very early buy signals in 1931, well before the 1932 lows. The losses from those incorrect signals undo a lot of the later positive calls it has made (when you average out the gains and losses, as he did in his article).

Then there's Jay Kaeppel (who I've never heard of before today), who says the Coppock Guide is useful, but not the way most people use it. Instead, he shows how using a different application of the system would have made a lot more money over the decades, and says that application is still at least a month away from issuing a signal.

The main point: simply to alert you that some other "long-term" trend indicators are lining up on the bullish side. As with the posts earlier in the week, I want to jumpstart the process of thinking about getting back into the market (or getting to your fully invested posture) in preparation for what looks like could be an all-clear signal as soon as a week from today.

It's always extremely hard to invest again after a big bear market. It would be twice as hard to do so "out of the blue" without any warning. So I'm providing some warnings to get you thinking about your plan and, potentially, provoke a gradual change in mindset.

Posted by Mark at 11:26 AM | Comments (0)
Category(s): Current Market Events

Email this post

More bullish fodder

As a follow-up to my post Tuesday, which likely left some readers shocked at the rapidly emerging bullish case, here are a couple other bullish points of view to consider.

Note that I'm not trying to turn everyone bullish all of a sudden — I just recognize this is a pretty sharp jolt for some, so I figured it might be helpful to look at a couple more examples from other sources seeing it similarly. We'll definitely be talking about the potential risks and how to respond to all this appropriately in the coming days/weeks, particularly if the all-clear indicator appears likely to trigger. What follows below is merely food for thought, not something to run out and take action on.

First up is a technical analysis expert. First, here's a disclaimer that we aren't huge on technical analysis, except as a confirming indicator. So I definitely wouldn't put a ton of weight on what you read here. But I found a couple things interesting in his article. One is how he points out that the near-term, intermediate-term, and now with the market blasting through the 200-day moving average, long-term (what he calls the "primary trend") indicators are all pointing higher.

A quick sidenote relevant to the 200-day moving average emphasis in his article — the S&P 500 dropped down briefly yesterday to touch that moving average and bounced immediately back up. That's potentially significant (or at least will be if it happens a few more times). Often, significant levels like a moving average will act as a "ceiling" until they're broken through, then switch and act like a "floor" after that point. What was resistance (knocking the market lower) can quickly become support (keeping it up).

A second confirmation of sorts comes from a totally different perspective, via Mark Hulbert. He reports on Jeremy Grantham's latest quarterly letter (PDF), explaining that Grantham has become quite bullish for the rest of the year. That's quite a surprise, for as we've pointed out a number of times here over the past 18 months, Grantham has been steadfastly bearish the past several years, and in fact called the recent downturn pretty well. For him to now be looking for a rally to S&P 500 levels of 1000-1100 (roughly another 7%-18% on top of the huge rally we've already had) by the end of 2009 is a bit of a surprise.

His reasoning though, is consistent with much of what you've been reading here at SMI. The article indicates that he expects a continued strong rally primarily as a result of the surge of stimulus money coursing through the economy (coupled with the liquidity being furnished by the Fed). Importantly, he's not nearly so optimistic about the longer-term, expecting the rally to fizzle at those higher levels rather than turn into a multi-year bull market. In other words, he expects a short-term rally based on the extraordinary government measures being taken, but ultimately expects that we'll have to take our medicine eventually in the form of slower growth and what he terms "disappointing" stock returns for some time after that. That idea basically echoes the last paragraph of my editorial this month.

What to make of all this? There are lots of conclusions we could draw. I'm not going to tease them all out here, but one take-away that's particularly relevant for SMI readers is the market can rally — perhaps significantly — despite the presence of looming long-term problems. There are always two aspects to market moves. There's the "what should be happening based on business conditions" element, which factors in all the stuff we've been concerned about lately (goverment policies, inflation, interest rates, business profits, etc.). But there's also a "valuation" element. If stocks overshoot to the downside during a market panic, the outlook may still not look that great, but stocks can rally considerably from those low levels.

One final point to consider. The last two bull markets have been extremly long. The last one was a full five years (Oct 2002 - Oct 2007). The one before that was almost 10 years (Oct 1990 - March 2000). It's very unusual for bull markets to last that long. The average bull market lasts less than 3.5 years, and it's returns are typically very front-loaded. This U.S. News & World Report article quotes Standard & Poor's as saying "the average bull market going back to 1942 has produced gains of 38 percent in Year 1, 12 percent in Year 2, and only 3 percent in Year 3."

My point is simply that some readers seem to be tripping over the idea that we could have a bull market with so many problems looming on the horizon. It's hard to get past the looming problems if you're thinking a bull market means several years of uninterrupted gains. It's easier to reconcile stocks moving up with the looming problems if you recognize most bull markets are much shorter than the ones we've most recently experienced.

Understand that we've already been in a bull market for several weeks if you use the classic definition of a gain of 20% from the prior lows. The question, of course, is whether this bull market will be short-lived — the classic "cyclical bull market within a secular bear market." We may have to wait a while for the answer to that question.

Posted by Mark at 9:27 AM | Comments (0)
Category(s): Current Market Events

Email this post

Market update

Over the past several months, we've written about a lot of trends in the economy and government that concern us. Some readers have expressed frustration with us for reporting on so many "negative" news stories and trends.

At the same time, we've consistently maintained that the market would turn around before the news got better. While we've conceded that some readers clearly needed to examine their risk tolerance and perhaps make adjustments in light of the steep bear market, for the most part we've encouraged SMI readers to stick with their plan and ride this thing out.

Many readers haven't liked this advice (to put it mildly). Some have left, in search of systems or seers that will move them in and out of the market in an effort to avoid the next bear market whenever it arrives. Market-timing never looks better than at the end of a bear market. On the flip-side, buy-and-hold investing never looks worse.

Then the market goes and rallies 40% in three months.

As difficult as it is to still be down as far as we are from the highs of 18 months ago, I can't even begin to imagine how it would feel to have sold at the March lows. And yet, logic tells us there are many people in exactly that boat, given the huge volume of selling around that market low.

Timing the market is an incredibly difficult thing to do. Which brings me as close to the topic as SMI ever gets.

As many of you know, SMI offers two very basic, very "big-picture" technical indicators for those inclined to add a dose of timing to their long-term investment plans. Our bear alert indicator gave a sell signal way back in January of 2008. (I think all of us wish we could go back and give that signal a much higher weight in our investment plans than we did then!)

The other signal that SMI offers is our "All Clear" indicator. This is a very-slow moving indicator. It isn't designed to catch the market bottom. It was purposely designed to be slow, because we were perfectly willing to give up the early part of a new bull market to try to make extra sure it didn't signal too early, before a bear market was actually over.

Guess what is getting close to triggering?

It's not there yet. But with yesterday's huge rally taking the S&P 500 index above its 200-day moving average, one significant obstacle to it sounding has been removed. The all-clear indicator relies on weekly closes (meaning the price at the end of the day each Friday). It would take a monster rally in the next few days for the moving averages to trigger the all-clear this week.

But all it would take for it to trigger next Friday is for the market to stay at or above the level where it currently sits right now.

Given that fact, it isn't particularly surprising to read that the top market-timing newsletter of the past 30 years (you knew I'd circle back to tie that in, didn't you?) switched to an aggressively bullish stance at the end of the day yesterday. Here's a brief rationale from the author's May 21 issue:

"During the early stages of bull markets, many investors will remain on the sidelines. They have a preconceived idea of where the market will go and will cite any number of economic concerns, as well as the warnings of CNBC pundits, to support their bearish case. Don't get us wrong; they might be right, but if history is any guide, the great majority of investors who were badly mauled during the bear market will not commit even a portion of their capital until it is much too late."

The economy is far from out of the woods. The news from Washington is troubling. The long-term outlook for inflation, interest rates, and our national debt all seem negative. But we've warned you for many months all that would still likely be the case when the market bottomed and the next bull market began.

Granted, we have no assurances the bottom is in. There are no guarantees when you invest in the stock market. We don't even have our all-clear signal yet. But the landscape has been shifting for several weeks now. Each level of gains has boosted the probability that the worst is over.

I thought it would be good to let everyone know the all-clear is getting closer than most probably would have guessed. Not that it's infallible. But for many readers, that's the signal they've waited for to re-engage with this market, and I'm guessing that most of those readers probably thought they'd have a little more time to get comfortable with the idea. It's never easy to recommit to the market after it's caused you so much pain. And, as the quote above alludes to, that's exactly why markets can bottom and run so far, so fast while the news is still bad.

It's time to start thinking through what your response will be if we do, in fact, get an all-clear signal 10 days from now.

Posted by Mark at 3:57 PM | Comments (0)
Category(s): Current Market Events, SMI Advanced Strategies

Email this post

More on TIPS

Yesterday, I linked to an article warning about the pitfalls of I-Bonds and reiterated that we think TIPS are a better way to add inflation protection to your bond portfolio. But that's not quite the end of the story.

Today, the Wall Street Journal points out the fact that TIPS mutual funds may not be as great an inflation hedge as you might expect. This is somewhat speculative, as TIPS are only about a decade old, and there hasn't been a period of significantly rising inflation during their brief life. So nobody knows exactly how they will behave. But that doesn't mean we can't make educated guesses, which is what this article does.

I encourage you to read the whole article, but in a nutshell, here's the deal. When you buy an individual TIPS bond, you get a fixed interest rate plus an adjustment for inflation. If you hold the bond to maturity, you get your full principal back. Pretty straightforward. The only moving component is the inflation adjustment, which moves up or down based actual measured inflation.

When you buy a TIPS fund however, you're buying a pool of TIPS bonds that have all manner of different maturity dates. Those individual bonds go up and down in value each day, primarily based on what interest rates are doing. In other words, with a TIPS fund, you introduce the impact of daily valuation changes into the equation, whereas when you buy a TIPS bond and hold it to maturity, there are no valuation changes. The individual TIPS bond is only going to fluctuate based on inflation changes, whereas the fund is going to fluctuate based on inflation changes as well as interest rate changes (which impact the demand for those bonds).

Here's how one expert interviewed for the article sums up these factors:

Anne Lester, a senior portfolio manager at J.P. Morgan Funds, has looked at how TIPS fit in a portfolio as an inflation hedge. During an inflation surge, she says, interest rates would be a negative for their prices. However, demand for TIPS likely would grow, supporting prices. Putting it all together, she says, TIPS would likely be a good shield against inflation, “but less inflation protection than you want.”

Ms. Lester’s group identified another set of circumstances that could lead to losses in TIPS: interest rates rising but inflation falling. Between July 1980 and July 1981, interest rates rose to about 15% from 10% while the CPI fell to 10% from 14%. The result: a“perfect storm” that could have sent TIPS down by about 20%.

Note that those hypothetical losses would impact TIPS fund holders, but not holders of individual TIPS who simply hold on to maturity. Those changes in value would apply if they were to sell their individual TIPS at that time, but could be avoided by holding to maturity, at which point their full principal would be returned.

SMI has typically focused on buying TIPS funds, primarily because it's so much easier for most investors. There are several good ones around, like Vanguard's VIPSX. But this does introduce a question regarding whether at least some investors might be better served going through the aggravation of buying individual TIPS bonds instead. They can be purchased through TreasuryDirect.

I'm not totally persuaded that everyone needs to suddenly quit using TIPS funds and start buying individual TIPS instead. The trade-off between maximum benefit and ease-of-use isn't completely settled in my mind. But it does make me think we'll need to ponder this "individual TIPS vs. TIPS funds" issue a bit more.

Bottom-line, we do think beginning to shift from traditional bonds to TIPS makes sense. TIPS are currently priced as if future inflation will remain low for many years. As you know if you've been reading recent SMI material, we too feel that deflation (rather than inflation) is the immediate threat. But we're also pretty convinced that as economic activity begins to pick back up eventually, so will inflationary pressures. If so, having switched from traditional bonds to TIPS (when they were priced for deflation) should pay off.

Posted by Mark at 2:36 PM | Comments (0)
Category(s): Current Market Events, Retirement

Email this post

Stay clear of I Bonds

Nearly a decade ago, SMI ran an article comparing and contrasting TIPS and I-Bonds. They were both relatively new products designed to help fixed-income investors protect their portfolios against inflation. Since that time, TIPS have become more attractive and I-Bonds relatively less attractive, and as a result, SMI has revisited TIPS several times while largely ignoring I-Bonds.

Still, there's a decent chance that some readers who are concerned about future inflation might be considering buying I-Bonds. Chuck Jaffe has some advice for you: Don't. He feels pretty strongly they are a bad deal right now.

If you're trying to get some inflation protection on the fixed income side of your portfolio, I would agree that TIPS seem like a much better choice. Here's what I wrote about TIPS back in February. Then in May, we mentioned that bond investors could start replacing some of their regular bond index funds with TIPS as a protective hedge against inflation.

Posted by Mark at