Hot Off the WebMarch 1, 2009

In Jason Zweig’s WSJ piece entitled “After the crash, Stocks may face a long road back”, reports based on historical evidence (Dimson, Marsh and Staunton of London Business Scholl) it is expected (i.e. 50% chance) to take nine years for markets to recover to 2007 highs. The data also refute the expectations that returns are significantly higher after the worst years (historically excess return over cash of 7.1% after 5 years) then after the best years (excess return of 6.8%). The report also questions the belief that stocks are riskless over the long run; there were four instances since 1900 when stocks dropped by >40% (twice within the last decade), and thus “often at the worst possible time” (like just around your retirement) such a drop “can wipe you out at various points along the way”. However, the good news is that U.S. stocks returns 6% real since 1900. Zweig then proceed to provide the reader with a liquidity test (one year’s worth of regular expenses, upcoming major one of expenses and <50% illiquid assets). However if you pass the liquidity test and are not retired, then you may be ready to buy stocks again (gradually at least and only up to you risk tolerance based strategic asset allocation; 7% excess return over cash or 6% real return is nothing to sneeze at if you can live with the risk).

Thao Hua’s “European plans on long-term equity diet” in Pensions&Investments reports that equity allocations in European pension funds will settle at around 40% as compared to the previous 60%. Though there are questions by some whom wonder as to where the “wholesale retreat” is heading to given that there is nowhere to retreat to.

Read Heather Scoffield’s interview with Niall Ferguson in the Globe and Mail’s “There will be blood”  “The global crisis is far from over, has only just begun, and Canada is no exception, Mr. Ferguson said in an interview before delivering a presentation to public-policy think tank, Canada 2020. Policy makers and forecasters who see a recovery next year are probably lying to boost public confidence, he said. And the crisis will eventually provoke political conflict, albeit not on the scale of a world war, but violent all the same. “There will be blood.” “(Pretty doom and gloom stuff that may be taken with a grain of salt, though Fergusson is a highly perceptive and insightful historian who is difficult to dismiss out of hand. For those interested in his historical perspectives of the world particularly in the 20th century may want to read his excellent “War of the World-Twentieth Century Conflict and the Descent of the West” book.)

In “Bottom fishing redux” the Financial Post’s Jonathan Chevreau struggles with what boomers approaching retirement should do next: cash out and settle for meager “safe” returns or, the other extreme, leverage into the market to make a killing. He personally chooses to “stand pat”, which is lot more sensible than the extremes. (At the end of the day we still can’t predict what the future will hold, and at times like these we might as well go back to basics. Look at our plan: objectives, constraints, risk tolerance, asset allocation, portfolio implementation and of course rebalance to your risk tolerance) as in the Education section of the website.)

“How bank bonuses let us all down” Nassim Taleb discusses how bonuses, supposedly used to “reward talent”, end up promoting risky and questionable financial behaviour “which periodically blows up, but in between allows you to collect your bonuses”. In effect, “as you do not disgorge previous compensation, the incentive is to engage in trades that explode rarely, after a period of steady gains.” “This mismatch between the bonus payment frequency (typically, one year) and the time to blow up (about five to 20 years) is the cause of the accumulation of positions that hide risk by betting massively against small odds. As traders say, they have the “free option” on their performance: they get the profits, not the losses. I hold that this vicious asymmetry is the driving factor behind investment banking.” “No incentive without disincentive. And never trust with your money anyone making a potential bonus. “(Problem must be the same as for hedge funds, though Taleb thinks this is less severe than for banks.)

The Macleans looks at the state of the Canadian housing market in “The shocking truth about the value of your home” . Many are caught having bought pre-construction units expecting to sell their current houses when their units were ready for occupancy; if they don’t/can’t close when the unit is ready they face not only loss of their deposit, but also the threat of the developer coming after them for drop in market price. The National Bank recently launched Teranet-National Bank House Price Index. They also initiated a forward (not futures) market allowing investors/speculators to bet on the direction of the Canadian housing market or to hedge a transaction that real estate buyer/seller is planning to execute in the future. “By buying contracts that paid out if house prices declined, they could help to recoup any money they lost in the housing market.” Upon the initiation of the market last December, it predicted a 20% drop in house prices between now and 2011, in sharp contrast with other sources of interested prognosticators (like real estate agents). Robert Shiller (of the Case-Shiller House Index fame) is quoted as saying that he’ll go with the prediction of the larger number of investors in the futures market than the best guesses of one or two economists at some institution.“It’s time to brace yourself, he says, because that bubble has popped. Over the coming years, houses will cease to be speculative investments, and will simply become places to live again.” You can view the index in six cities at Teranet-National Bank House Price Index newsletter.

WSJ’s Darrell Hughes reports in “Retirement: (U.S.) Budget requires savings plan” that “proposed budget requires employers who do not offer a pension program to implement a (default) direct-deposit retirement savings system”. Workers have the ability to opt out, however it is expected that this new default-to-save (rather than default-to-not-save) scheme will get low/middle income worker participation level to rise from 15% to 80%. The budget also proposes a 50% participation by the government in the first $1,000 annual contribution. Currently there are 75M Americans who don’t have an employer sponsored plan. (It is amazing how much more advanced that supposedly less caring American society is compared to Canada’s approach to pensions (better Social Security, better private pension insurance protection) than Canadians and now moving further ahead with an almost “universal” approach to pensions. When will Canadians wake up and demand that we do better as well?)

Terence Corcoran in The Financial Post’s “The model that’s killing pension plans” challenges the raison d’être of government run pension plans, taking inappropriate risk, rewarding the risk takers on the upside and passing the losses to taxpayers. Part of the “public pension investment activity is on behalf of unionized monopoly government service providers –hydro workers, police, municipal employees, teachers. All are set to receive relatively lavish pensions paid for by Canadian taxpayers who have no comparable pension plans.” (Publicly run DB pension plans, like private ones, are exposed to the vagaries of market volatility, because assets and liabilities are not matched. There are two ways to match these in a pension plan: you can primarily use fixed income asset to offset bond-like DB pension liabilities or live with the more volatile pension income stream sustainable with a more volatile (higher risk) pension portfolio. How long will the taxpayers put up with gap between public and private pension system, especially since they are paying the shot???)

Jason Zweig in WSJ’s “How managing risk with ETFS can backfire? Warns reader to beware of long or short leveraged ETFs which promise 2x or 3x the return when the market goes up or down. He points out that these are not buy-and-hold vehicles, but rather day trading tools (and day trading is one of the fastest ways to torn $100 into $50 on the market). These shares are not hedging mechanisms. The average holding period for some of these funds is measured in minutes and since markets don’t go straight up/down some of these shares can lose money in “unexpected” ways. Zweig gives example of an a China 2x short fund which, while $10,000 invested in the market would have dropped to $9,200 (-8%) may have been expected to increase to $11,600 (+16%), has instead dropped to $7,838 (-21%); and it did all this in 9 days!

And finally, Jeffrey Garten’s piece in the WSJ entitled “The dangers of turning inward” is well worth reading on the dangers/risks of protectionism.


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