Hot Off the Web- August 11, 2011

Personal Finance and Investments

Burton Malkiel writes that “Investors who resist the urge to get out during rough times like this will be glad they did” in WSJ’s “Don’t panic about the stock market”“No one can predict what the stock market will do in this and coming weeks. Stocks may continue their decline, but I believe it would be a serious mistake for investors to panic and sell out. There are several reasons for optimism that in the long run we will see higher, not lower, market valuations.” His reasons for optimism include: current P/E of 14, forward P/E of <12, dividends comparable to 10-year Treasury yields of 2.5% and “the structure of U.S. corporate earnings increasingly reflects economic activity abroad” and he concludes with “Indeed, it is in times like this that investors should consider rebalancing their portfolios.” (…of course nobody knows for sure where the economy is heading, and as Benjamin Graham used to say: in the short-term the stock market is a voting machine, in the long-term it is a weighting machine, so a serious economic downturn, or a political shift reversing the last 30 years of expanding corporate vs. labor’s share of income, can significantly alter corporate earnings that in turn could affect valuation. Of course you’ll have to guess whether government will rather drive inflation up before they’ll permit a serious economic downturn. Then of course there is the risk that falling stock market will result in a negative feedback loop further slowing and already (apparently) slowing economy. Ooops…I am beginning to sound like an economist (which I am not)…on one hand- than on the other hand, and before you know it I am going start believing my own B.S…. J…better head back to the (diversified) portfolio consistent with my risk tolerance and just ride this out.)

And speaking of gallows humour, McCrum and Demos in the Financial Times’ “Investors keep calm with gallows humour”quote a few observers/comedians as saying “Things were nervy and edgy but not panicky…Panicky is when you’re throwing things out the window. This move has been methodical, with steady, even distribution across all sectors” and “At least we have a president who can give a speech and calm the markets”…

Jason Zweig in the WSJ’s “Stocks are cheaper, but are they cheap enough” writes that “There are only a few reliable rules of investing. One of them is that perceived risk and actual risk tend to be inversely related: The more dangerous the markets feel today, the more likely they are to produce generous returns tomorrow. Fear has always been the best fertilizer for future bull markets.” He then looks at P/E ratio as a value metric for stocks. Shiller’s “cyclically adjusted” P/E “averaging the past 10 years of earnings and taking inflation into account” compared to 19.5 for the past half century. “They could go a lot lower. P/E multiples tend to shrink as uncertainty grows. When fear has turned to downright terror, the adjusted P/E has gone vastly lower than today’s levels, bottoming at 13.3 in March 2009, 6.6 in August 1982, 8.3 in Dec. 1974 and 5.6 in June 1932…The paradox, of course, is that if the market does continue to fall until valuations reach the levels of, say, March 2009, no one will want to buy. If you are a long-term investor, now is probably an opportune time to rebalance your portfolio, trimming back your bonds a bit and adding the difference to your stocks. But those who did buy stocks back in March 2009 should remember that the very thought of doing so probably made you feel sick to your stomach. That feeling doesn’t seem to be quite here again—not yet, at least.” The Economist’s Buttonwood is also “Looking for the bottom” and writes “Ignore the historic or prospective p/e (much beloved by analysts and CNBC) since they won’t mean much of the economy weakens. The best measure is the cyclically-adjusted p/e ratio which averages profits over a decade…According to Professor Shiller, the ratio was 20.7 at the end of last week, which makes it around 19.5 after yesterday’s fall. That is still above the long-term average of 16.4. The dividend yield is between 2 and 2.5%, on the FT’s various measures; even adding 0.5-1% for buy-backs doesn’t make that look cheap… (and) there are certainly signs of value outside the US, although the case is not overwhelming.”

In the Globe and Mail’s “Some dos and don’ts in this market”Rob Carrick has a pretty good list. Dos mentioned: stay cool, expect more volatility, consider a gradual/dollar-cost averaged buying (or rebalancing, i.e. sell some of what’s up to buy what’s down) opportunity, expect to lose more before things improve (this is very hard to do0. Don’ts include: consider resetting your financial plan (unless your assets dropped to a level where your risk tolerance might force you into annuitization), assume that you’ll recognize bottom, sell everything, chase investments that went up while everything else went down, buy investments “that promise to deliver true safety and good gains” (Remember a couple of more points: if your asset allocation was set up in accordance with your risk tolerance, you should be able to grin and bear it- at least so far, and with a significant asset drop one’s risk tolerance can change-both on the willingness and ability to take risk.)

For the last three months at least, gold appears to have delivered on its promise of providing some insurance against instability by being negatively correlated with stocks. Look at the following three month chart showing reasonable representations of the performance of gold (GLD) and the S&P500 (SPY) from Yahoo-Finance. Of course, a 5% allocation to gold accompanied by 50% allocation to stocks did not save your portfolio from a significant drop, it just eased the pain a little. (This is not a recommendation to buy gold!)

Jonathan Chevreau in the Financial Post’s “Don’t wait till death do you part”reminds readers that “Common-law partners here don’t have the same legal rights as married couples, says Sandra Foster, author of You Can’t Take it With You. “Unless you have your wishes in writing, you can’t assume you’re protected,” she says. After several years living together, “you are assumed to have been married from a tax perspective, but not in terms of rights of property in event of death…”

In the Globe and Mail’s “Retirees worry about market declines” Ted Rechtshaffen suggests that you consider which side of the “tipping point” (the point at which a retiree’s “wealth will neither grow nor decline as long as they live”) you’re on as a guide to whether they should be concerned about the market decline. Rechtshaffen admits that his example is a major oversimplification as he omits the impact of inflation and the indexing of pensions (…do people still have indexed pensions or for that matter any pensions in the private sector? He also included in the wealth of the retirees the value of their homes…that’s also a stretch when you consider that all you’ll have to sell or even worse take a reverse mortgage before you can tap the home…and perhaps if a large percent of the boomers suddenly decided to sell their homes there may not be enough buyers out there waiting to take the other side.)

In the WSJ’s “How to talk to your parents about money”Jeff Opdyke looks at the difficulties of discussing financial matters with you (aging) parents. Difficulties exist in asking (the right) questions by both parents and children. He suggests looking for an opening like: parents mentioning stock market losses or some major medical bills or some overdue bills. The advice is to “…avoid anything that sounds like blame….The worst thing you can do is to get mad, raise your voice, yell, or threaten to take control of your parent’s finances anyway or to seek legal advice in helping you take control. Such outbursts and threats only highlight parental worries that your true interests lie with the money—not their well-being. Along these same lines, don’t impose your will or take control of situations, accounts or decisions until a parent asks you to do so.” His other suggested approaches include: offering to research some subject of interest, or suggest visiting an attorney/financial-planner/estate-planner. He concludes with “You must act as though you are your parent’s personal fiduciary, and that means every action you take on your parents’ behalf must be unmistakably in their best interest, even if those actions ultimately mean you lose out on some or even all of your inheritance.”

Real Estate

In the National Post’s “City smashes 2nd quarter condo-sale record”Jane Switzer reports that “Condominium sales in Toronto in the second quarter of 2011 topped the previous record set in the same time frame in 2007 by 35%…The average selling price in Toronto in July was $459,122, up by almost 10% compared with the July 2010 average of $418,675…analysis acknowledged the “negative attention” over concerns about investor-fuelled condo growth, but said there is no need for concern as long as rental rates remain strong and the resale market continues to absorb the higher-priced, newly registered units.”


In InvestmentNews’ “Blackrock takes aim at Vanguard and Fidelity with indexed target-date funds” (see product sheet…it’s always interesting to look at the ‘glide-path’ of the target-date fund) Darla Mercado reports that “BlackRock Inc. may be touting its new indexed target date series, but it will face some tough competition from established players in the market….Currently, mutual fund giants The Vanguard Group Inc. and Fidelity Investments are among the best-known target-date-indexed-fund players. The two offer low fees and record keeping platforms. Indeed, Vanguard’s expense ratios range between 0.16% and 0.19%, and Fidelity’s Freedom Index Funds are capped at 0.19%. Net expense ratios for LifePath’s indexed series are much higher, ranging between 0.24% and 0.30%. Another selling point for Vanguard and Fidelity is their record keeping capabilities. BlackRock, on the other hand, is a defined-contribution investment-only player.” (The indicated costs are reasonable benchmarks for the proposed PRPP; but I am not holding my breath. Thanks to the CFA Institute Financial NewsBrief for recommending)

Ian Russell, chief executive of the Investment Industry Association of Canada, writes in the Financial Post’s “CPP increases are no silver bullet” that “Retirement-income policy affects a wide variety of people, at different stages in life, with different long-term goals and different short-term needs. A laser-like focus on the CPP as a single shining answer to retirement-savings problems has the potential to favour some generations unfairly at a cost to others.” (To use FUD (fear, uncertainty and doubt) to try to discredit even a ‘modest and gradual’ increase of the CPP in the eyes of the younger generation might be considered by some intellectually dishonest, since those just starting their working lives would be the greatest beneficiaries of any CPP increase, since increased benefits would typically be based on the number of years that one has made increased contributions. It’s difficult to consider seriously the self-serving comments of a representative of Canada’s investment industry even when there are some valid points presented (e.g. that CPP may not be the complete answer to everyone’s needs). This industry has lost all credibility by failing to serve the best interests of Canadians in the past (with few exceptions). As the old saying goes, don’t buy their products; buy their stock. But I am not even sure if that makes sense anymore; more and more people are realizing that the industry lost its way and is there exclusively to extract rents for its own benefit, so the future for the industry may be less bright…but perhaps the customers’ future will better.) In the Financial Post’s “Vanguard of change in fund industry”Jonathan Chevreau writes that “When the world’s cost leader in investment funds enters the one of the most expensive mutual fund markets in the developed world, something has to give….Vanguard’s imminent arrival also bodes well for the federal government’s new pooled registered pension plans (PRPPs)… Vanguard spokeswoman Rebecca Katz says the firm has a long history of working with DC pension plans and was an early proponent of automatic savings plans, auto contribution step-up programs, and well-diversified, low-cost default options like target-date funds.”

Things to Ponder

According to Di Leo and Sparshott in the WSJ’s “Fed pledges low rates through 2013”“the U.S. Federal Reserve signaled it plans to keep its benchmark short-term interest rate close to zero for at least another two years as it sharply downgraded its view of the U.S. economy…Fed officials discussed a range of policy tools to boost the economy, the statement said. Some analysts were expecting the central bank to say it expects its balance sheet to remain large for an extended period as well, but there was no time frame put on its continuing Treasury purchases.” Three FOMC members cast dissenting votes (an apparent first since Mr. Bernanke’s tenure).

The Financial Times’ Lex column in “US downgrade: a mere sideshow”suggests that focusing on the downgrade is missing the real point. “In a global context, investors should keep their minds focused on the here-and-now. Currently, the biggest risk to the world economy is not a US default – the ability to print its own currency means the worst that can happen is a continued gradual weakening of the dollar over decades. Italy and Spain, however, are hostage to the euro – a currency they cannot control.”

The WSJ’s opinion piece “America gets downgraded” suggests that the rating agencies’ “views are best understood as financial opinions, like newspaper editorials, and they’re only considered more important because U.S. government agencies have required purchasers of securities to use their ratings…Yet is there anything that S&P said on Friday that everyone else doesn’t already know? S&P essentially declared that on present trend the U.S. debt burden is unsustainable, and that the American political system seems unable to reverse that trend…as recently as 2008 spending was still only 20.7%, and debt held by the public was only 40.3%, of GDP.” Federal spending has been 25% of GDP the past couple of years and “debt to GDP climbed to 53.5% in 2009, 62.2% in 2010, and is estimated to hit 72% this year—and to keep rising.” Similarly, in the Globe and Mail’s “A credit rater that overreacted and overreached” Muzyca and Weiss walk through a list of reasons why “there is no reasonable scenario in which the U.S. government would default on its debt”. They also ask if it is realistic to suggest that U.S. is a worse credit risk than France or the U.K.? (…and the authors didn’t even mention that the U.S. can just start/continue/accelerate printing US dollars at will, so there is no risk of being ‘unable’, as opposed to ‘unwilling’ to pay its debt…the ultimate risk is not default but currency depreciation and inflation, rather than default…but then is there somebody who would argue that the U.S. (government and let’s not forget the consumer) hasn’t been spending like a drunken sailor for some time?) Also, Bill Miller in the Financial Times’ “A precipitate, wrong and dangerous decision” opines that “It is unacceptable that privately owned, for-profit companies should have special, legally sanctioned status at the heart of the financial system to function as quasi-regulatory authorities whose opinions can determine what securities financial institutions can hold, how much capital they need, what the borrowing costs of every member of the system will be, all based on secret deliberations with no accountability. The disastrously flawed ratings of these agencies were at the heart of the 2008 financial crisis and S&P’s action threatens to cause mayhem again by creating uncertainty about the ability of the US to function in its critical role in the financial system… By all means, let’s have S&P, Moody’s and Fitch opine about creditworthiness. But let’s have them do it in a free competitive market and not via a legally-sanctioned oligopoly which effectively regulates without oversight or consequence.” (I assume he disagrees with the rating, its timing, and the demonstrated (in)competence of the rater, as well as the appropriateness of a legally sanctioned rating oligopoly; tough to argue with any of that.)

Mohamed El-Arian in the Financial Times’ “Downgrade heralds new era”suggests that “…there will now be genuine uncertainties as to wider systemic impact of this change. With America occupying the core of the world’s financial system, Friday’s downgrade will erode over time the standing of the global public goods it supplies – from the dollar as the world’s reserve currency to its financial markets as the best place for other countries to outsource their hard-earned savings. This will weaken the effectiveness of the US as the global anchor, accelerating the unsteady migration to a multi polar system while increasing the risk of economic fragmentation… All of that said, there a sliver of a silver lining — and an important one. America’s downgrade may serve as a wakeup call for its policymakers. It is an unambiguous and loud signal of the country’s eroding economic strength and global standing. It renders urgent the need to regain the initiative through better economic policymaking and more coherent governance….a “Sputnik Moment””.

The Financial Times’ Lex column’s “US exorbitant privilege: What price?” wonders given “…the dollar has gained whenever fear has spread in forex markets. That suggests the exorbitant privilege adds about 10 per cent to the greenback’s value. This a valuable privilege indeed. The cultural-economic puzzle is why Americans are putting so little effort into maintaining it.“ (It is amazing how much self-inflicted damage can be caused by an ideologically polarized America with politicians (as usual) focused of personal rather that the nation’s best interests.) And John Kay in the Financial Times’ “Loans to a king do not always pay”writes that “For centuries people realised that the special status of the sovereign made lending to the king risky: rich individuals and sound ventures were generally safer investments. Kings could default, or pay in devalued coin, and there was nothing the angry lender could do about it. The sovereign lender must not only risk his capital but brave the ingratitude that borrowers often display.”

In Bloomberg’s “Ending the moral rot on Wall Street-Part 1” William Cohan writes that “What will it take for Americans to finally get the message that much of Wall Street, in its current form, is a corrupt enterprise in need of a top-to-bottom overhaul, a task that the year-old Dodd-Frank law, for all its verbosity, barely attempts?” He lists the litany of “accounting shenanigans…(and) manufacture and sell mortgage-backed securities that were stuffed with loans of questionable value, plus the worthless AAA ratings placed on them by ratings services paid by Wall Street to do so. Also the business model that encouraged bankers and traders to take asynchronous risk with other peoples’ money with the knowledge that by the time things went wrong, billions of bonus dollars would be paid out, and no effort would be made to hold anyone accountable…Was all of this immoral, unethical and illegal behavior a mere aberration, brought on in the years leading up to the financial crisis by an atypical combination of greed and hubris? Sadly, no. Rather, it was of a piece with a continuous line of dubious behavior that has characterized parts of Wall Street for generations…“The bigger and better question may not be whether insider trading is rampant, but whether corporate corruption in general is rampant, whether ethical bankruptcy is on the rise, whether corrupt business models are becoming more common?””

In the Financial Times’ “Time to rethink tail-risk protection” Vince Heaney writes that “there is an important distinction between…Black Swans, which are highly improbable, unpredictable events, and “predictable surprises”, which are a better description of most financial shocks. Predictable surprises have three characteristics: at least some people are aware of the problem; the problem gets worse over time; and eventually the problem becomes a crisis much to the surprise of most. On this definition, Japan’s tsunami was a Black Swan, but the sub-prime crisis was not, as several money managers made fortunes by betting on the market’s collapse. As Black Swans are unpredictable by definition, the only effective hedge would be to buy downside protection in a wide range of asset classes, at all times. Obviously such a strategy would be punitively expensive and counterproductive. Predictable surprises, on the other hand, at least give investors a better chance of finding a more cost-effective hedge… When it comes to cost effectiveness, the bad news is that pretty much everything on offer is expensive… A more attractive alternative is manager diversification – investing with a contrarian fund manager who specialises in looking for ways to profit from doomsday scenarios.” (The analysis appears to be correct but the recommended solution is unlikely to work, at least for the average investor.) In the Bloomberg’s “Universa, Pimco posted gains on Black Swan funds as market fell”Miles Weiss also discusses tail-risk insurance.

Garry Marr in the Financial Post’s “Try the retro retirement”looks at a couple who retire at 50 “to live their dream: a no-frills retirement that lets them spend time with grandchildren, volunteer in the community and get in a few rounds of golf.” While Marr does not indicate the income or expenses of this couple, he quotes an advisor saying that “It comes down to expectations, she says. She breaks down retirement into categories. You want to live what she calls your grandparents’ retirement, which includes living in a modest home in a small Canadian town with low-budget vacations, and it can be done for $35,000 a year. “You can live comfortably on very little and your needs are covered, but that leaves very little for wants”…Other categories include living off a private pension for what she calls the million-dollar retirement or a globetrotter lifestyle.”

And finally, Matt Gurney in the Financial Post’s “The public is ready for health-care reform, why aren’t politicians” reports that the conclusions of the recent CMA public consultations are: “need for the health-care system to better address aspects that fall outside of what’s generally covered: long-term care, home care and pharmaceutical expenses…(how Canadians will pay for increasing costs) “through the single-payer public system, with government serving as the Grand Redistributor,  or through private transactions and insurance…(but they) seem at least somewhat reconciled to the notion that the private sector will play a role in the delivery of care in the future. (Whatever approach is to be taken we do know costs will increase with aging demographics.)


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