blog28may2009

Hot off the Web– May 28, 2009
MF, a reader of this website, brought to my attention Consuela Mack’s May 22, 2009 interview of David Swensen on PBS. Well worth the half hour of your time to listen to the Yale CIO’s clear thinking and articulate communication about what individual investors should do. A few of his key points (and there were more): (1) Swensen started writing his new book “Unconventional Success” to translate the Yale model to individuals and concluded that it was impossible; his conclusion is that you must be at either one end of the continuum (very active) or the other (completely passive), and an individual cannot be at the very active end, (2) recommended individual asset allocation in his book (I suspect for an investor with average risk tolerance) is 30% US stocks, 15% Treasuries, 15% TIPS, 15% REITs, 15% foreign developed country stocks and 10% emerging market equities. (3) given current fiscal and monetary stimulus, inflation is a high probability outcome, so every portfolio should have TIPS, in fact if you buy newly issued TIPS you also get protection against deflation.Dan Richard writes in the Globe and Mail’s “Bring discipline to your portfolio”that investors’ emotional reactions to market volatility drives them to buy high and sell low. He indicates that earlier this year “while they might have been prepared to hang in with their existing holdings, they could never have brought themselves to reduce the bond and cash positions that had done so well and heavy up their stock weighting. And yet that’s exactly what investors committed to automatic rebalancing would have done.” (I.e. having a system to remove emotion from decisions!) A target asset allocation (with specified rebalancing rules) based on an Investment Policy Statement seems like a good way to go, he suggests.Jason Zweig in WSJ’s “If you think the worst is over, take Benjamin Graham’s advice” suggests the following based on Graham’s advice. “…stocks have moved from the edge of the bargain bin to the full-price rack. So, unless you are retired and living off your investments, you shouldn’t be celebrating, you should be worrying.” This is because for those who are still in the asset accumulation phase, they’ll be buying full rather than sale priced assets. Graham’s “inverted emotions” approach meant that when the market was down he’d see it as a market opportunity and vice versa. As to dollar cost averaging he said “Such a policy will pay off ultimately, regardless of when it is begun, provided that it is adhered to conscientiously and courageously under all intervening conditions.” Zweig suggests that you must resist being swept up by market enthusiasm “when stocks are no longer cheap”, like now.

Jonathan Chevreau in Financial Post’s “Dr. Doom’s prediction U.S. will suffer Zimbabwe-like hyperinflation fuel for gold bugs”  reports Marc Faber’s prediction. Gold and real-return bonds are given as suggested hedges against runaway inflation.

Ruth Sullivan in financial Times’ “UK’s first longevity swap draws a crowd” writes that corporations are looking for ways to hedge the longevity risk associated with their pension plans. “Each extra year a scheme assumes its members will live adds 3-4 per cent to its liabilities, according to the Pensions Regulator.” The market for such longevity swaps is not very competitive due to limited number of players, “50-60 year term and uncertainty involved”. (The interesting number here for those looking at the impact of using very liberal mortality data, i.e. old rather than current mortality tables, in the valuation of DB pension plans results 3-4% increase in liabilities to correct for each underestimated year of longevity in plan population. A 2003 TIAA-CREF research paper indicates that “age 65 life expectancy (has been) increasing at about 1.5-2% every five years”; so having the most current mortality data and forecasted conservatively into the future is essential for an accurate valuation.)

Pauline Skypala’s Financial Times article “Time to rethink the long equity bet”questions the wisdom/safety of UK government having built pension systems on the assumption of (generous) equity risk premiums. Outcome will differ for individuals depending on what happens near their planned retirement date. She reports that some now suggest that the best way protect against market risk is with insurance, though cost may not justify the approach. The UK pension authority is leaning toward providing a low risk default fund, but a pension consultant quoted indicates that “personal account default fund would have to be 60 per cent in equities to satisfy the assumptions built into the projections for the 20 per cent replacement earnings the scheme“ based on equity returns of inflation plus 3.5%. Skypala writes that it appears that “The equity bet has become the default setting around the world as individuals everywhere are increasingly expected to shoulder all the risks – investment, inflation, interest rate and longevity – of financing their retirement.” (Longevity insurance, on a national scale could protect individuals against personal longevity risk, while still collectively absorbing the smaller risk of increasing overall longevity.)

Jon Chevreau reports in the Financial Post on “The paradox of surging early retirement claims”. “Social Security’s chief actuary Stephen Goss suggested another wave of older workers may opt for early retirement when they exhaust unemployment benefits later this year or early in 2010.” This is despite various surveys indicating that individuals planned to delay retirement for an average of six years . (Not a pretty picture.)

In the Financial Post article “Ottawa to permit pension plus pay” Paul Vieira reports on Ottawa’s proposed changes relating to CPP. In addition to making it easier to work while collecting CPP, the proposal will add some pain for those wanting to take their CPP early but reward those who are prepared to delay their pension. Specifically, 36% vs.30% reduction at age 60 and 42% vs. 30% increase at age 70. For those who could afford to delay their CPP payments it generally was advantageous to do so even before these changes, however for those who must take early CPP this just adds to the pain. (You need to carefully look at your personal circumstances, but I’d err on being late rather than early.)

Reading McCarthy, Keenan and Howlett’s Globe and Mail article “Taxpayers fork out billions for GM pension aid”, it sounds like the deal struck by GM with Canadian and U.S. government financial assistance “spares the pensions of existing retirees, but current workers face significant cuts to pensions and benefits” . (Is this a favourable indicator/precedent for Nortel pensioners?)

Financial Post’s Jamie Sturgeon in “Nortel case- Option holders caught in tax trap” reports on another plague to fall on some current and ex- Nortel employees who received options which they exercised (perhaps at share prices >$100) and then held in the hope of further appreciation. The excess of market price over the exercise price is the basis of the income tax owed, though tax changes allowed tax payment to be deferred until the sale of the stock. Unfortunately, those still holding the now worthless shares may have to now pay those deferred taxes, if the shares end up deemed to have been disposed of as part of CCAA process (by sale or liquidation). Some individuals may owe tens or hundres of thousands of dollars in taxes even though the shares have now close to zero value. (It was risky (bad) investment decision to exercise and not sell immediately, but outcome still sounds punishing.)  There is precedent where JDSU employees in similar bind were given special dispensation by Ottawa. If the shares remain worthless, with no deemed disposition, then no taxes would be due.

Florida real estate broker Mike Morgan writes in Barron’s “The housing hurricane will howl again”, that we are in the eye of the storm and soon we are about to enter the “back half of the storm”. Foreclosures, on hold between January and March, will be back to hit us with full force again as new inventory will hit the market. He argues that prices have to reach the point where an investor can buy and rent out the property at break-even, and we are not there.

And sure enough in you can see the latest (April 2009) depressing numbers in “Home prices continue downward march”, “A look at Case-Shiller numbers by metro area” and the complete Case-Shiller historical data available at S&P Case-Shiller Home Price indices. Only Charlotte, Denver and Dallas showed no drops. The 10-city composite, Miami, NYC and Seattle showed one month and one year drops 3.5%, 2.5%, 2.1 % and 2.2%, and 29%, 12%, 17% and 19%, respectively. (Florida realtors’ data may be showing some light at the end of the tunnel in “Hitting bottom? Palm Beach County housing market, national economy shows signs of life?, but their self-serving pronouncements in 2005 and 2006 suggest critical analysis and interpretation.) Bottom not reached as yet, as per the graph below:

Case-Shiller Housing Index April 2009

WSJ’s Brett Arends triggered by the latest Case-Shiller report asks “Is your home a good investment?” . His answer surprisingly to many, is – No! The 10-City Case-Shiller index covering the intervals from 1987 (peak) and 1994 (trough) to today show housing appreciation equal to inflation + 1.15%/yr and 2.2%/yr, respectively. “You can often do better on long-term inflation protected bonds.”

Roger Nusbaum in Globe and Mail’s “Case-Shiller funds fraught with risks” discusses  a couple exchange traded products (DMM and UMM) which allow you bet on or hedge the direction of Case-Shiller housing index; in fact the “funds will deliver three times the move in the index”. He points to that between monthly index valuations there is no guarantee that security price is tracking (unobservable) index value. Nusbaum suggests that while the fund will be popular with speculators, “reliable hedging seems nearly impossible”. (Not sure why that is so, based on price straying from underlying value between valuation, since you could set your closing to coincide with valuation dates- but no doubt there are other considerations as well. There is a similar Canadian housing index based product under consideration as well.)

And finally, Bloomberg’s Matthew Lynn in “Latvian hookers signal no recovery for economy” has identified signals to watch for recovery. He suggests that those who look for recovery signals at the Baltic Shipping index, money supply or housing recovery are all wrong. The “two benchmarks we should all be monitoring more closely: extramarital affairs and the price of Latvian hookers. Both are telling us that there is still plenty of trouble ahead.” When bulls or bears rage activity at a UK dating website for married individuals shows significant increase (like now), while “When it (market) is trading sideways, they stick with their partners.” The Latvian hooker market where prices have collapsed by 2/3 this year, also signals trouble ahead.

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