New Insurance Premium, Ouch

Every year in late October we get our annual notice from our health insurance provider telling us how much our monthly premium is going to go up. Last year it went up by 20%. This year's notice came with news of an almost 12% bump.

Maybe I have this wrong but while there may be uncertainty on what will happen with Obamacare not much has actually happened yet (in relation to what was promised, or threatened depending on your perspective) but the newness of the Obamacare concept is no longer with us and so I don't think they can legitimately blame a policy that is no longer new for the gouging.

It seems pretty obvious that this expense is going to continue to increase at a rate well above the reported rate of inflation.

One aspect in my role on the Fire Department is that I participate in just about all of the medical calls. One normal part of the process is to ask what medications the patient is taking which can be important in treating the patient in the field and for whatever treatment the patient might receive at the hospital.

The reason to bring this up is that based on my casual observation people have a lot of prescriptions that must be refilled on some regular interval. The costs of these prescriptions of course goes up as well and depending on the insurance coverage this could result in more expense for the patient.

As this relates in large part to retired people living on a fixed income it underscores what most people know on some level even if they haven't tried to map it out which is healthcare expenses will be a nasty variable expense.

A couple with $2000 in social security income and taking 4% from a $200,000-$300,000 portfolio probably can't easily absorb a 50% increase in medical costs every five years (simple math) or in our case a 30% increase in two years. Sadly portfolios of even $200,000-$300,000 is probably unrealistically high.

There is no answer that will make people happy. I don't think it is realistic to expect the government to create an effective regulatory framework that creates a competitive industry, doesn't create resentment by customers or otherwise have hideous unintended consequences.

While I don't think there is a happy answer there is a simple answer. Save more and spend less.

On a different note the Madoff interviews on 60 Minutes were fascinating although I'm not sure I can pinpoint exactly why. Whether they were guilty or otherwise complicit they have clearly been crushed as a result. Ruth seemed very medicated and I can believe she blocked out as much as she apparently did even if it was along the lines of "it's not a lie if you believe it."

I have to admit I don't watch 60 Minutes very often but it seemed like every commercial was either for pharmaceuticals or financial services which was interesting too.
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Sunday Morning Coffee

The Barron's cover story was their "Big Money Poll" and I stumbled across something in there that leads to a broader question worth exploring. In there was mention that Lockheed Martin (LMT) is yielding 5.30%. That is pretty substantial for a defense contractor.

Many decades ago it was typical that stocks yielded more in dividends than bonds yielded in interest payments with the logic being that the dividends were meant to be a compensation for taking on the risk of owning the common. Along the way this changed, for most stocks anyway, and we came to expect to get more yield from holding bonds, and more price stability too.

The last decade has been odd for stocks. Although decade long round trips to nowhere are not unprecedented they can create a catalyst for some sort of meaningful change. After the last decade long round trip to nowhere the change was an 18 year run of spectacular returns. Perhaps the change that comes from the current decade long round trip to nowhere is a reversion to stocks yielding more than bonds--if so then really it started a couple of years ago.

We are not there yet at the index level as the S&P 500 is still close to 2% which if we looked we might find is attributable to the relatively large financial sector not paying much in the way of dividends. I made a reference the other day to how many semiconductor stocks yield close to 4% and if you look around you will find many more stocks (excluding REITs and MLPs) with pretty serious yields.

At the March 2009 the SPX yielded more than the ten year as a function of the yields for both stocks and bonds being distorted. Bond yields are still distorted but as of right now stocks are clearly not at a panic low and so probably not distorted, at least I don't think they are.

If this is a reversion to a bygone era where many stocks will yield more than many bonds then this would not be a valuation call to buy equities as the idea here is that this could persist for a couple of decades. This is not to say that stocks aren't cheaper just that I don't think it is a catalyst to immediately rocket higher.

One positive from this could be that yield from a portion of the equity part of the portfolio could offset the reduced yield that most people are having to endure from the fixed income side of the portfolio. The downside, and this is more behavioral, is that too many people will get caught at some point with too much equity exposure for not remembering that dividend stocks are not high quality bonds.
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Friday Tidbits

First up is a comment or two on the current goings on in the market. The action of the past few days, and really for the month of October, has been a buying panic. This buying panic came after a selling panic in September. One of the two months (you can decide which one) is closer to what is appropriate given the total backdrop we are working in now.

The bear case ties into the feeble housing and employment numbers combined with desperate action being taken by central banks in many corners of the world. The bull case ties into quite a few data points showing signs of improvements, some aspects of the earnings for the quarter looking good and a very impressive rally over the last four weeks.

Take whatever side you prefer but I would point out that most of the time these types of monster moves do occur during bear markets. There is nothing that says this can't be a bull market because it is possible that the worst is behind us, that we will never go below SPX 1200 again and that the market has turned up in advance of an economic turnaround. This is not my base case but it could be correct. We did not get as defensive as we did in 2008 but as I've been saying all along, on the way down you always wish you owned less and on the way up you always wish you owned more.

Today would normally be the day that we begin to redeploy some cash but we recently switched custodians to a firm with a more robust foreign offering and it is not logistically plausible to trade in these markets late in the day Friday. As I am more interested in adding foreign, if we add anything now I will plan on next week.

One weird element of the SPX' dance with the 200 DMA is that it went below at about 1283 in the middle of the summer and when it took it back almost three months later it did so at 1274. The 200 DMA stayed remarkably flat and obviously it is still tilted slightly downward and the 50 DMA is still well below the 200 DMA.

A reader left a comment asking whether it makes sense to avoid putting foreign holdings into 401ks or IRA for tax reasons having to do with what is withheld from foreign dividends. Not everyone has both types of accounts first of all. Secondly taxes are one of those things where people have their own thoughts about what to do and from the standpoint of being a portfolio manager the normal course of action as I know it is to simply honor any requested mandates along these lines when possible and after any potential downside has been explained to the client.

Finally there was an interesting thread the broke out on several blogs including Felix Salmon and Abnormal Returns that stemmed from a Twitter fight between Keith McCullough and Steve Liesman about going on TV too much.

Felix's argument (and Abnormal Return's too but not quite as loud) is to question how can someone who manages money be on TV constantly. They have a job to do and being on TV so often is time not spent doing what people pay you to do; manage their money.

Being on CNBC's "G" list (a reference to Kathy Griffin Life on the D list) I go on two or three times a year and I will say it is fun to do. I got to do a segment from the NYSE floor a couple of years ago and that was a blast.

Without accusing anyone else of being a self-promoter in the manner Felix does I will say I don't understand how people do their work done while appearing so much but they must figure out how. My idea of the work is that most of the time is spent reading. I read a lot of news and I read about companies. Other managers may have other ideas about how to do the job which is just fine.

Certainly there must be team situations where being the face of a group or firm on a very regular basis is the job. For however many times I have been on I've had to say no just about the same number of times usually for not being able to take the time and there were a couple of instances where I would not have been able to add value to their viewers (insert joke here about never adding value to their viewers).

The implication from the linked posts is that the work product suffers for the time spend being a pitch man. For someone who is inclined to hire someone the client must be on board with what is going on with any and all aspects that matter to them.

I would say the most important thing is to be on the same page philosophically as the manager. If you hire a DFA guy then you will ride the market up and down fully invested. That is not bad or good but simply a philosophy that someone hiring a DFA guy must be on board with. Asking about process, or how the day is spent or whatever else is fair game but no one will change their routine for you.

Someone who hires us knows I work from home and that once, maybe twice, a month I will have a fire or medical call, usually medical, that I have to go on (obviously this is something I choose to be a part of my life). Anyone is entitled to think this is unacceptable but then that person should not hire me. Someone who goes on CNBC a couple of times a week should not be expected to alter that behavior so if you can't live with that then you should not hire that person.

I will say it was fun reading the Twitter fight.
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Very Important Technical Formation

I like to move it, move it.
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Now That Would Be A Disclaimer

A reader left the following comment on the Seeking Alpha version of my post about the Fairholme Fund from the other day.

I'd be more impressed if these Monday morning quarterbacks had been around warning investors during Berkowitz's good times.

But that would be the hard part, wouldn't it?

I left sort of a smart alecky comment in reply;

Warning about what exactly? "Hey the manager might do a couple of really dumb things two years from now so you might want to avoid the fund."

I went on to mention that the type of blow up that has occurred this year at Fairholme can happen to any concentrated fund even if the backstory might be a little less sensational.

This brings up an important investing dilemma that I believe exists and contributes to why so many people complain about 401k plans. Berkowitz was a master of the universe for a decent amount of time (some believe he will regain that status again).

Unfortunately there is no way to know what an active manager will do in the future. You can know what the strategy is and hopefully likely to be but the exact trades are of course unknowable which makes the funds essentially impossible to analyze. With an actively managed portfolio you are expressing your belief in the strategy and that the past success can be repeated. You might draw the correct conclusion about a fund in that context but this is not really an analysis.

Most 401k plans are a mix of index funds which are simply asset class exposure and actively managed funds which might correctly fit into some Morningstar box or might not. I have seen some plans where the offerings are shockingly thin. I looked at one plan recently with only 12 choices of which there was only one international fund (there was also a global fund).

We have another client who has dozens of choices in his 401k. While too many choices can make the task daunting there are many plans that simply have a dreadful selection with not only funds but even asset classes. The one above has no choices for emerging markets or foreign fixed income.

Many times I have used the typical 401k results that get published every so often as the reason for why we should not have privatized Social Security accounts. Based on published studies, the 401k results are dreadful. Some of this is clearly attributable to the choices available.

More and more employers are moving to running their plans through brokerage firms such that employees have what amounts to a brokerage account with access to stocks, ETFs and traditional mutual funds. This is a boon for people interested enough to do some work but I do believe there is some burden on employers to provide access to at least some education on the subject.

The number of 401k-like plans that exist as brokerage accounts is pretty small at this point which leaves most plan participants having to make choices that amount to nothing more than guesses that some active manager won't make some sort of catastrophic move in the portfolio.

The good news is that most fund managers don't blow up the funds they manage, I say most but we know not all. If most of them underperform their benchmark that is unfortunate but it is not catastrophic. If you were in a plan with only one equity fund and it went up 7% per year versus 10% for the market then clearly that will compound into a big lag which I repeat is a bad thing but that type of scenario can be overcome with increased savings whereas recovering from a serious blowup might not be possible.

I doubt there are any one choice 401k plans but the numbers are understandable. A lag can be mitigated. Perhaps the education needs to be your employer is giving you crappy funds to choose from that you should expect will lag the market so you need to save more money than you are saving now.
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Netflix!

The blowup in Netflix has been epic on multiple levels and provides a great reminder for what I would call a very old lesson about investing in certain stocks. Netflix is, was and always will be a fad stock in my opinion. This can be even in the face of a very useful or convenient product but not all fad stocks have something as convenient as Netflix as their main product.

There have been a lot of these over the years of course some of which you may not even remember and at the very least you have not thought about how hot these stocks were both in price action and media attention. Do you remember how hot Snapple was once upon a time? Bottled ice tea trading like it would change our lives.

What about Andrea Electronics? Do you even remember that one? I don't recall what the product was but it went wildly parabolic in its 15 minutes. Comparator was another one from way back when. Of course there are many others as well.

The first AOL.

The nature of these tends to be the same in that there are always a lot of people who make a lot of money in these on the way up. The story is always compelling in one way or another as potentially life altering (in a good way). As I've said many times the actual internet has far exceeded the hype from the mid 1990s but it did not have the expected result on the stock market as many related stocks are trading at a fraction of their share price from 12 years ago and many others of course disappeared.

At some point for no reason (or any reason) the music just stops. Netflix is down 72% in three months which probably means the music for this one has stopped. Assuming the party is over for the stock the service is still very convenient which will always have a decent appeal (I realize subs went down a little over 800k) but maybe the future is that at some point it gets absorbed into another company or competitors come into the market offer something that, as far as the end user is concerned, is the same service.

When the music does stop people get crushed. The people getting crushed is always some combo of people who held on too long with too much and people who got in very late.

There will be stocks like this of course that come along in the future. The strategy here is quite simple which is sell some as it whizzes higher. You don't have to sell all of it but selling a 1/4 or 1/3 or 1/2 of the position every 50% or 100% or any other strategy is a good way to make sure the eventual implosion that you probably won't see coming (and good for you if you do) doesn't do you in. Had you tripled your original investment in NFLX and then reduced your position by selling 2/3 of your stock by virtue of making a couple of sales on the way up, then the current implosion is far less of a traumatic event.

The above example may seem ludicrous but it is far from impossible that that some stock you own goes parabolic for whatever reason making some sort of risk management prudent. If you start with the assumption that this one is not different and that rules of risk still apply then you can still do very well and not give it all back.
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Diversification Rules Be Damned

RBS launched a new pharma ETN with ticker DRGS. It appears to be a large cap, global tracker similar in a lot of ways to many of the other health care sector ETPs, there are probably a dozen ETFs with large weightings in Bristol Myers (BMY), (Merck) and the other usual suspects.

What is interesting about this fund, from a where is the industry going standpoint, is that the underlying index only has 16 components. The names held also include Glaxo, client holding Novartis (NVS), Abbott Labs (ABT) and you've probably heard of all of the others.

The ETN wrapper apparently allows for fewer holdings than ETFs. I wrote an article about the Disk Drive ETNs recently which track an index with only eleven constituents. ETFs need to have at least 20 holdings and it appears that ETNs don't have this burden. There have been jokes before about single stock ETFs which are meant to take the specialization to an extreme.

I have no idea who needs another choice in global health care sector products but this does raise the possibility of the ETN wrapper offering access to themes or niches where there are not enough stocks for an ETF. Off the top, an ETN for Scandinavian banks or Chinese toll roads would offer non single stock access to relative health in the case of the former and relative non cyclicality in the case of the latter.

The big obstacle here is the ETN wrapper. ETNs are unsecured debt of the issuer. The banks that did not fail a few years ago are unlikely to be allowed to fail now but I don't know why anyone would take that on in the face of an alternative that does not take on this added element and with healthcare there are of course many funds.

An ETN for some segment where there is no ETF for whatever reason becomes more plausible than what appears to be a me too product. The RBS' Trend Pilot funds offer a unique enough solution that some will be willing to take on the risk.

The other drawback is the dividend. Most ETNs do not pay a dividend. The 16 component index yields 3.3%. The ETN will not pay out a dividend however. The index will still capture the yield (probably 2.7% after accounting for the 0.60% expense ratio) but it will be reflected in the share price as if it was being reinvested. Not getting an actual payout is more of a psychological obstacle to overcome but it does need to be overcome to consider the product and obviously anyone taking income from their portfolio would need another wrapper that had an actual payout.
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Berkowhathappened?

Barron's had a feature on the recent goings on at the Fairholme Fund (FAIRX) which is primarily managed by Bruce Berkowitz but the fund has always been pitched as a team effort. Assuming Barron's has it right I can only conclude that this is and has been a truly bizarre situation.

Read the article but there were odd implications surrounding giving giving a seat at the table to his cousin's husband which seemed to have contributed to the departure of Larry Pitkowsky and Keith Trauner who went on to start the Good Haven Fund (GOODX) and it seems like the magic may have left with them.

There were lawsuits from ex-employees and really it just creates a very odd picture. The article also lays out a theory about how difficult it would be for the fund to unwind it's positions, if it had to, based on average volume of the stocks and a sort of unwritten rule of not wanting to exceed 20% of the day's volume, apparently the fund is more concentrated than most concentrated funds.

I've picked on this fund quite a few times along the lines of how I have picked on the Bill Miller funds, everyone gets things wrong and no one beats the market forever or under all market conditions but the risk in making not just huge bets but more like career makers (or breakers) time and again creates a consequence that probably can't be recovered from when the bets become breakers.

I suppose there is an argument to be made for an investment pool to take these kinds of outsized risks but probably not one that is available to unaccredited individual investors who bought a mutual fund because it was on the cover of some magazine as a hold forever fund because of a great ten year track record.

The article leans more eccentric than egoist but perhaps ego has been a component here? Certainly that would not be a surprise anyway. Learning from someone else's downfall is no doubt opportunistic but it is also helpful.

Congratulations to the All Blacks from New Zealand on winning the Rugby World Cup. They made easy work of most of the tournament but France, whom the beat in the final, has always been difficult for them as was the case in the final but when I saw the French's first reaction to the Haka was to hold hands (not lock elbows but hold hands) I felt good about the kiwi's chances. While I know how the scoring in rugby works, I don't get the rest of it.
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The Big Picture for the Week of October 23, 2011

The other day I read yet another article about how to capture yield in this environment of zero percent rates. We've not made any radical changes to what we've been doing fixed income wise in the last few years as US rates have been low and generally gotten lower and the visibility for them to remain low for quite a while is pretty clear. I have not changed my belief that the US' fundamentals argue for higher rates but market prices diverge from fundamentals all the time.

A common case being made these days is that investors should buy dividend stocks instead of bonds. If you want do that just realize that dividend stocks are stocks not bonds and have volatility characteristic of stocks not bonds because they are stocks. There is a reason why most people have some sort of mix of stocks and bonds; they tend to react and behave differently. The manner in which a dividend stock may react to various factors might be relatively muted compared to the broad market but they are merely different shades of the same color.

To the extent people need income from their portfolios (so not talking about the accumulation phase people) one suggestion is to add some yield to the equity portion of their portfolio. This is not a call to change the asset mix but to increase the yield of one portion. This can be done several ways but I will say I think it is easier by using individual stocks instead of funds.

So with the energy sector an equalweight allocation is low double digits. That is enough to take in something like Statoil (STO) which we have owned for years and usually pays 4-5% in dividends or some other big cap foreign stock with a similar yield. There is also room to take in an MLP or two and those yields range from 5-9%. Something yielding 5% will probably be less volatile than a 9% yielder so maybe one of each MLP (that being one 5%er and one 9%er). There would still be room for something that was more growth oriented which might come from some theme with good prospects. This mix obviously tilts to yield but is not exclusively yield oriented.

With the tech allocation, someone needing more yield might have luck with a semiconductor stock. There are a lot of them that yield above 3% with quite a few near 4%. Financial stocks typically have decent yields but I would suggest looking at banks outside the US, Big Western Europe, Japan and China. There are some relatively healthy smaller US banks with good yields but this is difficult work.

There are also higher yielding products that should be treated like equities to consider. We owned one a few years ago, MIC, and it got crushed in the crisis. That it got crushed was not a big deal because our exposure was so limited. Something like Brookfield Infrastructure (BIP) could work but I would expect it and anything like it to get crushed should there be some sort of 2008 repeat. Own one of these in moderation then it is just an inconvenience like MIC in 2008, own a bunch and it becomes a problem in a 2008 repeat.

As for actual fixed income, yields are low. If the yield of an entire fixed income portfolio is not low right now then there is risk being taken. That is only bad if the end user doesn't know that risk is being taken. A large portion of what we own are short dated, high quality domestic corporate debt and the yields are very low but better than treasuries. We are not taking meaningful interest rate risk with short maturities because of how soon they come due, mostly 2013.

I've made a big deal over the past few years about owning individual issues of sovereign debt from other countries. Some yields are quite good and some are very low and we have a mix of both. Again these are short dated. Just about everyone has Australia and some have New Zealand (a little riskier than Oz) which is where we get decent yield. For Norway we rolled to 2015 when our 2011's matured in May and that yield is pretty good but not in the fours like Australia.

We have one closed end fund that we use as an across the board holding (we have a couple of other ones in our ownership universe). Relative to closed end funds this one is quite stable pricewise. The yield is pretty good as you can imagine and it does feel big market moves but it usually has a muted reaction when CEFs in general are puking down. It is a very old fund, and the reason not to mention it by name is there are plenty like this to find, research for yourself and then buy if you are so inclined. But again some of these get crushed, I specifically want one that is very likely to not get badly hurt. If you take more risk here than me then you will get a higher yield.

We have two preferred stocks that we use heavily; one from a big US bank and one from Public Storage. That might seem like a surprise given how lousy I think the banks are but thinking they won't go out of business is not really an argument for going long the common. The yields here are pretty good or like some of the other segments I've mentioned we could even say the yields are about "normal."

One other segment to mention is that we own the PowerShares Emerging Market Bond ETF (PCY). The bonds are dollar denominated but currency moves can move the price of the bonds. The yield is around 5% but as this is an ETF there can be no certainty about what future dividends will be. it is not terribly volatile but occasionally there is some noticeable movement.

We have a couple of other things but the point here is that the collective yield is not zero, I believe we have spread out normal market risks so that we are not over exposed to any one part of the market.

Bigger picture, I believe it is very possible to get some yield out of a portfolio but remain diversified--not selling out for yield at any cost.

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Investor Awareness?

A thought occurred to me as I read this article from IndexUniverse about four new low volatility ETFs from iShares. The overall education level of the typical investor (talking someone with a brokerage account as opposed to someone whose only involvement is through a 401k) has improved versus where it was in the 1990s.

If you ask most ETF providers why they create the products they do they will most likely tell you that these are the funds that their clients/customers want from them. While there is probably more to it than that there is the belief that a demand is being met.

We are seeing a lot of funds coming out that offer a low volatility spin on some broad index including the four new ETFs in the above article. We've covered the extent to which lower volatility concepts, when executed correctly, can offer a better long term result by going down less and going up less over the course of a full stock market cycle, or as I have described it; smoothing out the ride. You should be able to find research on this as there are many different ways to capture the same general effect.

If there is new demand, compared to years past, for products that target better risk adjusted returns then I take that as a sign of more investors understanding the concept of risk adjusted returns on some level. I don't think this existed 15 years ago.

I believe we also know far more about foreign markets, how certain aspects of macro economics impact countries and markets at a far deeper level than we used to--this as a function of the macro economic failings of so many countries.

If we do know more about these things, it is because the seemingly dreadful stock market results of the last eleven years and the financial crisis of the last four years (or longer) have caused more people to ask more questions, rely on fewer assumptions and seek out better answers.

This will not prevent the same old behaviors from every other past big bad event from manifesting themselves as some people will always panic, be done in by misusing leverage one way or another, be too confident and so on. I will repeat this probably only applies to people engaged enough to have a brokerage account but I do believe this is meaningful progress.
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Round Up All The ETFs

I've really gotten a kick out of all attention ETFs have gotten in the last few days but I wasn't sure exactly why and then it clicked; scapegoatism. We are having severe financial problems on an almost global scale (I say almost because there are plenty of countries that have just been dealing with cyclical downturns) and "we" need someone or something to blame it on.

The crisis came about from some combo (define it however you want) of a flawed regulatory backdrop and greed on the part of people (banksters if you like, and people who lied on mortgage applications). We are now at a point where the newness of it is long over but in the most affected countries there does not appear to be an end in sight.

This is slogging on with various market abnormalities (real and perceived) with no signs of returning to the way it used to be and so we need something blame. Actually we need more than one thing to blame as blame for one thing exhausts we need something new to blame.

Right now the blame directed toward ETFs is relatively intense. They are distorting the markets in several different ways, the non-plain vanillas pose serious risks to the unsuspecting, investing public and they cause obesity in children--yeah, it's been scientifically proven.

This is a manifestation of herd mentality that I think is similar to the need to explain things along the lines of the market was down today because... We need to understand why even if that means blaming the wrong thing for the wrong reason or somehow just not being correct. As I've said a couple of times the blame-ETF meme misses the mark in terms of understanding how much of the current malfunction is attributable to ETFs--far less is attributable than people think. Although I concede that they might contribute to distortions, they are a small and possibly insignificant part of the equation. It is even possible that it is something else that is distorting ETFs in such a way as to make it look like it is ETFs' fault.

We did not understand what the financial crisis really was in real time (we probably don't fully understand it yet, several years after it started) and so I believe we are very unlikely to understand what it really distorting the market in real time.

Some traders will be able to trade this environment and some won't. But how is that different than any other time in market history? Some investors will keep their heads and navigate through fairly successfully and some others will not. Again, that is the same as any other period in market history. Invariably that will draw comments telling me why this time is uniquely unfair or whatever, but it is not as different as many think.
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The Stock Market Dropped Yesterday Because It Did

This appears to be the market we have right now, it was up on Friday just because and that was the same reason why it was down yesterday. I say this not to point out something new as it has been going on for a while but simply pointing out that this is what the market is giving us.

As a matter of investment philosophy this is an environment where I would rather try to shave off the peaks and troughs as the market seems intent on grinding around in the same range. The intent would be to go down less if the SPX goes back down to 1100 as we went up less as the market went from 1100 to 1200 the last time.

One relevant point I may not have conveyed adequately is that while I took defensive action consistent with how we always do it, I disclosed the various trades made along the way, and I do believe a recession is in the cards I do not believe the stock market action will be anywhere near as bad as late 2008/early 2009. We have been in the slogging through phase for a while and I think that will continue. A low from here of 900-1000 might sound terrible but it is obviously nowhere near SPX 666. The 900-1000 range is not meant to be a prediction so much as trying to have some expectation of worst case magnitude. Obviously I could be wrong and if we get to 900 or 700 then, as I have said before; however much defense we'll have taken by then we will wish we had more--human nature.
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#OWS Evolves

The Occupy Wall Street movement (and the other locations being occupied) seems to have escalated in terms of protesters v law enforcement clashes. As I said a few days ago, I do not take this lightly even if I do not fully understand where they are coming. You don't need these protests to know that some aspects of our financial and economic system appear to have changed and may not be "working."

The reason I hedge in that last sentence is that we are still in the middle of the event. I believe this event will turn out to be very historically significant but if we are still in the midst then we probably do not fully understand the context of the event. As bad as the OWS movement thinks it is, maybe when we look back on this in 2020 or 2025 we will conclude it was worse than we thought or hopefully we'll think it was not as bad as it seemed.

As I also said in my other post on this, the OWS movement is trying to ask some difficult or uncomfortable questions. Actually I think they are still trying to figure out what they really want to ask--still trying to find their voice.

One of the ideas emanating from OWS seems to be that they (here we're talking about the younger protesters) did what they were "supposed to," they went to college but incurred a lot of debt and now cannot find work that gives them a chance to pay off that debt.

One of the retorts to this aspect of the protest is to criticize them for majoring in medieval folklore (a little humor is ok) and expecting that major to have any value in the job market. Early on in my college career someone wisely told me that there are only three undergrad majors; accounting, engineering and everything else which I took to mean that companies don't hire your major (except for those two), they hire you. Someone else told me that unless you go to Harvard, Yale or Stanford it doesn't matter where you go.

With that in mind I went to San Diego State, got a BA in econ and graduated with $3000 in student loans that had a minimum payment of $100 per quarter. When I was college age I was interested in having as little student debt as possible as I knew I would have to pay it off. Hence I chose a school that cost me $300 for my first semester. Has the thing about majors and schools changed? Were they never actually true? There are relatively cheaper ways to get through school like going to a community college for the first two years.

The logical reply to my comment about companies hiring you not your major is that there are fewer jobs available coming out of school. While that might be true in the traditional sense I believe the internet is a great tool for people looking to make their own way. I don't mean on a Zuckerbergian scale but more modestly. As an example, go look at some of the younger contributors on Seeking Alpha. There are quite a few guys right out of college producing content and making some money. I doubt there are too many 24 year olds making $10,000 a month with their blogging but someone who writes prolifically might make $1500 and if they can't find a "real" job then maybe they have a not so good job for now while they are young and putting their time in to try to become successful.

This sort of combo of starting out on your own with what you want to do/shit job has a low barrier to entry. There is nothing wrong with this sort of sacrifice in pursuit of what you want to do. I've disclosed previously that before this part of my (internet based) career took off I took side work around here like putting on a roof, doing logging, and building a rock wall. We needed the money and I was (and still am) too cheap to raid our savings.

I realize there is a lot to be down on right now in our country but I believe that there is ample opportunity for those who can really apply themselves. Maybe many of the OWS protesters are doing this but not talking about it much as it might be bad for business, I mean protesting.

Some things do need to change and I am glad these people are asking some questions but their "list of demands" will probably need to evolve some to make the movement more practical and relevant.

This post was longer than I thought it would be but this could be important and might help the country light a fire under its ass if the right questions get asked in a productive manner.
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Sunday Morning Coffee

Herb Greenberg had a post on Friday titled Proof: ETFs a Self-Fulfilling Prophecy which cited a report by energy analyst Michael Bodino from Global Hunter Securities about increased correlation that he feels is being caused by ETFs which in turn is contributing to the Markets Are Broken meme that Herb has been writing about lately.

First in response to Herb's tweet, I do not think he is an idiot (no idea if that tweet was directed at me or not).

Let me clear that I do believe certain ETFs are having some sort of influence on markets in an unintended consequence sort of way but that it is not the magnitude of problem that some think and more specifically I contend that we do yet fully understand this issue. I don't believe the effect is as powerful as some believe but time may prove me wrong. In the mean time we are still trying to figure it out and if anyone has actually figured it out yet, they are not telling anyone.

The focus of the article is 2x and 3x ETFs with the first point cited by Herb that they "create an artificial market for the stocks they own." Keep in mind the report is from an energy analyst not an ETF analyst. So the first thing is the 2x and 3x don't own any stocks they own derivatives. In the course of trading these ETFs there is hedging that might go on to fill a kind of large order and that might make its way to a some of the larger stocks eventually (domino effect) but the more direct cause and effect would come from creations and redemptions where shares are created by buying derivatives which is actually more like increasing open interest in futures or creating OTC swaps. Again the hedging here by whoever is providing the exposure might make its way to stock trading, I say might.

Average volume in DIG, one of the funds mentioned, is 1.8 million shares and the market cap is $295 million. The average dollar volume for DIG is around $80 million. The DUG ETF (double short energy stocks versus DIG's double long) has average dollar volume of $60 million. It might be too simplistic to say that this nets out to $20 million per day but there is some offset and it may not be too simplistic for there to be a one for one offset. Whatever the net effect, I contend it is not enough to have the impact on the entire sector as claimed by the Bodino report. On an intuitive basis this simply is not big enough to be the only answer and it might not even be a meaningful contribution to the increased correlation cited.

There is also mention of the extent to which investors, by way of trading ETFs, are trading in stocks they would otherwise never own. Taking an example from the article, no one thinks about Parker Drilling when they buy an energy stock ETF but the ETF trading is creating volume in the stock that wouldn't otherwise exist, so says the report. As mentioned above, this is not a universally correct idea. There might be more volume but there does not have to be.

"However, when investors buy and sell long and short ETFs on the open market, they are transferring money to long and short ETFs to purchase or sell short certain securities which in turn create a self-fulfilling prophecy across the industry as the money flows move in and out of the underlying securities."

Again, the vast majority of the time this will only apply to creations and redemptions which are usually 25,000 share trades or 50,000 share trades.

Also in reference to this point, anyone remember buy programs? Before ETFs there were baskets of actual stocks purchased, which is a direct increase in volume. Twenty years ago this might have meant buying a basket of energy stocks to reflect the XOI index. I realize buy programs also means trading SPUZ futures based discounts and premiums to fair value.

Herb also references the report's number crunching on increased correlation in the energy sector which is also tied to levered ETFs. This overlooks the extent to which the correlations of foreign markets to the US has gone up in recent years.

Yes there are 2x and 3x country funds but the volume is miniscule. Of the single country funds I only found two from ProShares with volume more than 100,000 shares; ProShares Ultra Short China (FXP) and ProShares Ultra Short Brazil (BZQ). From Direxion there was just the Daily China Bull 3x (YINN), but there were a couple of others close to 100,000 shares.

Correlations to all sorts of things are up but circling back to the theme of this post the ETF explanation simply does not fully account for what has happened.

Herb might be correct that 2x and 3x funds should be shuttered (not my base case) but the argument put forth by Bodino and echoed by Herb does not go anywhere fully accounting for what has really happened and again I contend we as an industry do not yet know the entire story and if we eliminate these funds tomorrow it will not hasten a return to normalcy.
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The Big Picture for the Week of October 16, 2011

A couple of days ago Fitch lowered ratings and/or outlooks on seven European and American banks citing economic challenges and potential changes in regulation. While this by itself may not be a big deal, it is simply the latest in an ongoing saga that has now literally lasted for years.

Over the course of these last few years I have continued to say that there will be more shoes to drop and the the fundamentals will continue to stink for a long time to come. This is still the case even if this Fitch news is quickly forgotten.

There are two prongs to this argument that I think make this an easy call. One of which is the ongoing global, economic malaise where new policy ideas continue to be thrown at the wall, where neither jobs nor housing show signs of natural demand coming back soon. If economic activity remains sluggish, or worse, then it makes sense to expect the banks to struggle on a fundamental basis although there can always be good trades had along the way.

The other prong here is market related. While not a perfect comparison (the financial crisis has been worse), the Nasdaq is down 46% from a high hit more than 11 years ago. In the same time Cisco is down 73%, Microsoft is down 40%, Intel is down 58% and Dell is down 60%. Obviously some names have done well but I believe it is correct to say that we are still dealing with the aftermath of the tech wreck and will be for many more years. If the financial crisis was worse, or maybe it would be correct to say more significant then there will be many more years of aftermath.

While I have always said there can be good trades there is an element of picking up nickels in front of a steamroller for now. This will continue and it is my contention that this will go on for many more years.

The investment implication can be a simple as avoiding the financial sector altogether (not my first choice) or for people comfortable enough, there are segments that are on firm fundamental footing. I've been saying for years that we've had luck with Chilean and Canadian banks. We had owned an Australian bank that we sold in June and while I think Aussie banks are healthier than US or European banks I think the housing market down under poses a threat although not with the same magnitude of what happened to US housing. After we sold our Aussie bank it went down a lot, in line with XLF but has snapped back much quicker of late. There may never be a consequence from the Aussie housing market but I believe the threat has worsened.

There are other segments within the sector that I also believe are on better fundamental footing like many of the publicly traded exchanges around the world. That is not to say that exchange stocks won't be volatile or go down a lot if the market goes down a lot but if I am right about the fundies, then a large decline becomes an opportunity as opposed to the US and European banks where a large decline merely becomes the latest chapter in the saga.
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Friday Randoms

The other day I saw a post on Seeking Alpha by a site called Street Authority that listed 20 foreign stocks that currently have single digit PE ratios. I'm not a huge fan of the "319 Stocks Going Ex-Dividend This Month" types of articles but for whatever reason I clicked on it and the names were interesting.

Their list (and their PE ratios);

Anglo American (AAUKY) 2.7
Roche Holding (RHHBY) 3.6
Lukoil (LUKOY) 3.8
Vale (VALE) 5.0 we own this one
Volkswagen (VLKAY) 5.1
Arcelor Mittal (MT) 5.1
Rio Tinto (RIO) 5.3
Posco (PKX) 5.3
BP (BP) 5.5
Petrobras (PBR) 6.1
Total (TOT) 6.3
Teva (TEVA) 6.4 we own this one
Itau Unibanco (ITUB) 6.7
Eni (E) 6.8
Royal Dutch (RDS) 7.3
Statoil (STO) 7.3 we own this one
Sanofi (SNY) 7.4
AstraZeneca (AZN) 7.6
Honda Motor (HMC) 7.9
Nissan Motor (NSANY) 7.9

A few things here. First you need to double check for yourself that the numbers are correct. Occasionally stocks get very cheap in this way and while there is no guarantee that a low PE stock will go up soon it can make for a very good entry point for a name that you would otherwise want to own. Obviously you need to have some basis for being favorably disposed to the name, expect that the earnings will grow from here or more correctly are not about to drop in half. That the earnings might be forecast to cut in half isn't necessarily a reason to not buy but it becomes a different type of trade--not bad, just different.

But if you do like a name, the PE is single digits and you do believe the story is in tact then it is a good entry point even if the stock gets cheaper (you can't bottom tick every stock you own). While this is maybe Investing 101 stuff the idea is important and the list is interesting.

I got a kick the other night out of the GOP debate on Bloomberg TV. It was the first debate I watched. Of particular interest was the fuss around Herman Cain's 999 plan which in case you missed it is 9% personal income tax, 9% corporate tax and 9% national sales tax. Cain is right that this would be a serious change to how the country does a lot of things so I like the idea of raising the concept. The situation that the country is in is going to require some serious changes in how we do things and it is unlikely that this will occur in such a way that every will be happy about it.

If I understand the specifics of it everyone would pay 9% income tax. Everyone paying their equal share has an appeal of course but it would crush all the people who don't pay tax now. Maybe those people should pay tax or maybe not but the fact is many do not and going from zero to 9% would crush them and thus be a big drag on the economy IMO. A flat and simple tax could work but the only way to get it passed is exempting some portion of income, the first $50,000 maybe or some other number that was practical.

I am a fan of a national sales tax but if I understand Cain's plan this would include groceries, medicine and energy products. This would crush people below a certain income level. National sales tax; yes! On groceries, medicine and energy products; no. There might be some other things that should be exempted but people who meet some description of wealthy will consume all the same. While I don't consider myself to be wealthy, I will not let a $25 national sales tax prevent me from replacing our espresso machine when the current one breaks. Again, I like the concept here not the specifics.

From what little I have read and heard it appears as though the math on the 999 plan doesn't work but ideas like this where people don't get crushed does advance the conversation.
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Blow Up Revelations

One secondary theme in the last couple of weeks has been the extent to which certain well regarded hedge fund managers have had very poor returns, surprisingly poor. The loudest of these has probably been John Paulsen with some reports having him down 47% YTD. I also recall reading that Whitney Tilson was down in the mid 20s but while I could not find that when I searched I did find this quote from him that "nobody lost more money or feels worse about our fund's performance over the past year than we do." Also the Tilson Focus Fund (TILFX) is down 23% YTD. We've also talked at great length about Bill Miller in this context.

In all cases there have been large bets on financial stocks along the way and of course it turned out that the financial crisis, as manifested in stock prices had not ended (and still hasn't) when they put these positions on. There is not much utility in saying someone shouldn't have done something because aside from the fact that it is too late, they did it, they would be lauded as having "done it again" if these trades worked and whatever the size of the bets, they might be smaller than the bets they made in the past that worked--meaning they have have dialed down the risk but it still didn't work out.

The more useful thing to take from this for investors with more modest goals (like just having enough when you need it) could be to understand what will happen to your portfolio if some number of your assumptions are wrong. Assuming a portfolio goes narrower than some combo of SPY/EFA/IWM then there are assumptions built in to the portfolio. Looking out over 12, 24 or even 60 months we might each pick several of our holdings to be likely candidates to be the best performers. It is not very likely that the ones we think will be the top performers will actually turn out that way.

The best example of this I can think of is our purchase of Advanced Auto Parts (AAP) early in 2005. The thematic reason to buy it is pretty obvious and the company seemed like it was sound and it ended up far exceeding my expectations. This is an argument for owning more than just your favorite holdings.

In just owning ten favorites, for example, or concentrating on just several areas the consequences for being wrong are magnified. Add on top of that the consequence that can go with using leverage as appears to have been the case with Paulson. If you need to put 30% into bank stocks because you think they can't go down anymore then you have to realize that is a big bet. BAC is down 50% YTD, GS is down 41% and C is down 38%. No one made big long bets on these names expecting those results but that is what happened and based on the results of the funds there appears to have been no mitigation for being wrong. It doesn't matter if you use a price drop as a trigger to sell or not own so much that being wrong and holding on seriously or permanently impairs your capital (James Montier refers permanent impairing of capital on a regular basis).

This is why when I overweight or underweight a sector I only do so by a few percentage points, why I don't put 15% into any single foreign country and why individual stock positions are usually targeted at 2-3% of the portfolio.

Part of the psychology here is that we are all going to have things we get wrong, it is unavoidable and of course we can't really know what macro thesis will be the one (or more than one) that we get wrong. You're probably not going make a long macro bet on Mexico if you thought it was on the verge of imploding.

Worrying about being wrong is not the right way to go as opposed to worrying about the consequence of being wrong. If in a bad year, personally, you are flat in an up 10% world or down 10% in a flat world is not the type of thing that will necessitate a financial plan re-write. Something like Paulson's down 47% in a down 5% world will.
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Herb Greenberg Says Markets Are Broken

There seems to be a lot of commentary around the interweb lately about various aspects of markets, financial systems and ideologies (like capitalism) being broken. These are worth exploring in terms of trying to figure how to get along if these really are broken or even if they are just frayed around the edges. Herb Greenberg had a related post yesterday.

Going point by point on Herb's piece;

1) A fixation on the macro.

Herb contends that macro factors are more important these days in terms of dictating market action than anything else. He appears to be implying that this is different than how it has been before. He might be right about the macro tail being different now but as someone who believes in top down I would say that the macro has always been more important.

I've made a big deal over the years as to why I have been underweight Europe and US financials since before this site started. I've made just as big a deal over how simple the macro work was to lead me to these conclusions. This was far easier than had I tried to come at this from the bottom up. Herb mentions being "tied to the whim of the latest hand-wringing over the European financial crisis." Here's some simple macro work; do you know there is a crisis in Europe? Well then avoiding ground zero for the crisis and other parts of the market most likely to be affected might be a good idea. Avoiding ground zero is easy, figuring the other segments most likely to be affected will take a little more work but would not be impossible.

2) The Internet.

I think his beef here is that you can't always know the qualification or motivation of the person writing free research that is available. This strikes me as being small potatoes compared to the extent to which the internet is a democratizing force for both consumers of content and producers of content. For consumers of content there is access to people that would otherwise have no easily heard voice. Without the internet would we have any idea who Mike Shedlock, Edward Harrison, Cullen Roche or Bruce Krasting are? How much less informed would we be without them?

Think of all the data for individual stocks, data for foreign countries and on and on. I can't see the internet as a net negative.

3) High-frequency trading.

Herb shared a consensus the HFT is contributing to increased volatility but he was so brief on this point that I don't think he puts much importance on this point. I talked about this a few days ago. I don't doubt that there is some market influence here but whatever the extent of the influence is it is short term in nature, so less relevant for long term investors, IMO.

4) Last but not least: ETFs.

This is mostly about 2X and 3X ETFs tied to broad indexes moving markets. The volume of these funds looks like it does increase in the last hour of trading and the daily reset process does cause trade at any price volume. Maybe this is yet another reason to avoid broad indexes if your account is large enough.

In this point was something useless about the number of ETFs increasing even as the number of stocks are decreasing. There are still many more traditional funds than ETFs and some ETFs are offering access to segments to which there was previously little or no access except through individual stocks.

All investment products have positives and negatives, end users need to weigh them out for themselves and then decide. It is pretty clear that Market Vectors Vietnam ETF (VNM) or the First Trust Global Wind Energy ETF (FAN) are not disrupting market activity, distorting volatility or otherwise having an unintended ripple on the world. Focusing on that makes ETFs pretty benign but if you can only focus on what the levered, broad based funds might be doing then you would think they are malignant and probably not use them. The third choice might be that you believe they unduly influence the market and you try to exploit that.

My message about ETFs has been the same which is they are tools for access with positives and negatives that need to be sorted out by each end user.

As for the bigger question Herb tries to answer about whether the market is broken I imagine many would agree with him although this is not the most productive way to view it. As a repeat theme the previous decade shows us that markets can go up without the US. Broken or not this is world we live in. As another repeat theme avoiding the potential gain in global equity markets is valid but means accepting tradeoffs like saving more or getting by on less.
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Forget About Stocks?

Jim Bianco raised some interesting points in a recent interview that are worth exploring. He was very critical of the Stocks for the Long Run mentality even singling out Jeremy Siegel. The building block for his thesis is that we have something of a large sample size that favors bonds over stocks which is the opposite of the argument that he says many financial professionals make. Bianco goes on to say "we don't understand the fundamental relationship between stocks and bonds."

There are a lot of things to consider here for anyone caring to draw their own conclusion. The tenet being attacked is that the more risk we take the more reward we get. Stocks are riskier than bonds so we get more reward from owning stocks. The last eleven years hasn't quite worked out that way which is a reason to ask some questions.

My comments all along about bonds, meaning US treasuries, is that they are expensive. They may stay this expensive for a long time or get more expensive but they are expensive. Buying the wrong part of the curve now only to have rates then go up would seriously impair capital. Buying two-three years out would not really impair capital but might leaving you with below market yields in your portfolio for a little while if you can't sell. I've disclosed before that we own a lot of short dated corporates and a lot of short dated foreign sovereigns.

A building block of this site has been the extent to which plenty of foreign markets have had very good, or at least "normal," run as US stocks didn't. US stocks have had lousy decades before so the experience of 2000s is not unprecedented. From a purely contrarian viewpoint, and based on the 1930s and 1970s, it would not be crazy to think the next ten years could be pretty good. However, right here right now, there is no fundamental case IMO for the next ten years to be pretty good but there probably wasn't a good case in 1940 or 1980 either.

To be crystal clear the above is more about what has happened in similar events before, my base case continues to be a muddle for US equities with "normal" returns coming from foreign markets ex-Big Western Europe and ex-Japan.

Bianco says we have to admit that we have a problem. I think many did that a long time ago (I'd like to think I did that many years ago) as collectively we all know far more about foreign markets than we did ten years ago.

The line of thinking expressed by Bianco is correct when applied to US equities, at least I think so, but just looking at US stocks (if that is what he is doing) is incomplete.
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Exploring The "Retirement Bubble"

David Merkel had a great post up that he titled The Retirement Bubble. The post was thought provoking as were the comments on the Seeking Alpha version of the post. David covers a lot of ground and if I am reading him correctly, he and I draw some similar conclusions about the idea of traditional retirement and the viability of various programs that are in place that the country is relying on to be there.

The post did not do much in the way of exploring alternatives in an opportunistic sort of way as I try to focus on. I am not sure if David has touched on this in other posts or not. He covered the fact that for many people the solution will involve working longer, living on less (two that I mention often) or defaulting (I usually don't cover this ground).

Some of the comments were along the lines of how I like to come at this as a problems in search of an unique (for you) solution. There was one commenter in particular who mentioned having made $30,000 last year on a side business. He said it took time to get to that level and at one point talked about this as being his hobby. Long time readers will recall that I have been writing about figuring out how to monetize a hobby for many years--I just mentioned this last week.

Another comment called for a small scale exodus from the US as more people who came here for their advanced education will return home instead of staying and that a relatively large number of newly retired Americans will move to somewhere like Panama or Costa Rica for the lower cost of living. As a side note does anyone have information about how many people that leave the country at 60 or 65 come back for healthcare reasons in their 80s? Obviously someone who stays healthy and just expires at 94 probably wouldn't need to come back but someone needing care starting in their early 80s, for example, who was living abroad would have to at least consider returning. In that light is coming back feasible?

There were others about income inequality, the potential resourcefulness of Americans (reading between the lines, if the government would get out of the way), an acknowledgement that not everyone can keep working until some age they think of as being old and the no fault of their own argument. There were also comments along the line of age warfare (similar to class warfare).

In terms of viability of social security and medicare, as a guy in my mid-40s I expect nothing. Maybe it won't go bust but if there is a means testing then I would anticipate being left out. There was a comment on David's post that really took issue with this idea because we have all put in, so we should all be able to take out. Ok, but I simply believe that the reality, versus what should be, is that many will not be getting these checks. I will gladly take the $3000 (the amount that my annual statement says would be our combined benefit) as in today's dollars that more than covers our expenses but needing that $3000 in order for my financial plan to work would be a bad place to be.

Instead of no fault of their own (I hate this saying) let's call it wrong place wrong time. There is no question that getting a nest egg to compound during a lost decade or two is very difficult, most will not be successful. Whether a stretch like this comes along and when it comes along is a function of luck and otherwise based on factors you cannot control. Ok, what can we control? We can live less of a lifestyle than we can afford which would allow us to save more money. As an oversimplification, if we have 40 years to accumulate savings (and we invest most of the savings) we can expect the stock market to "work" most of the time but if it doesn't or doesn't at a personally crucial time we have to be ready to adapt as we are entitled to nothing.

Obviously I am big on working longer if possible both for financial reasons and health reasons (staying active in this way might keep you healthier longer). The one commenter who said he made $30,000 with a hobby is a great example. For someone who lives a modest lifestyle $2500 (assumes the revenue is actually that linear) could relieve a huge portion of the burden off of the portfolio. Depending on the hobby it could still be doable even with some sort of impairment that is a function of old age.

Many of these issues can be mitigated or partially mitigated with certain lifestyle choices. At 50 years old there is no way to know that you will be healthy and strong at 75 but a serious commitment to exercising and a few simple diet choices (no soda) can vastly improve your odds. The benefits here are clear. In addition to feeling good later into life there would be more options available for someone who wants to work or needs to work.

Where we live there are all sorts of seasonal jobs with various parks, forests and so on that require being on your feet. This type of work will obviously be much easier for a 70 year old who physically is more like 55. This is not like standing in a retail store for 40 hours a week all year but a more of a physical challenge for six or eight weeks which I think are two different things. A month or two of full time pay would relieve some of the burden off of the portfolio as well.

As far as income inequality; yes it exists and it appears as though it is as bad as it has ever been based on various ways of looking at it. Unless you can figure out how to monetize speaking out against this issue then I am not sure what good it does to preoccupy yourself with it, and again I concede this is a problem.

The age warfare is interesting. In the comments where was blame placed upon the boomers and an expectation that they should get out of the way of the younger generations. We can see that the boomers are not getting out of the way and there is some impact because of this on other segments of the population but in reality both groups will have to adapt. To the extent boomers are staying longer perhaps this is how they are adapting. I'm not sure how younger people are adapting (not a shot, I don't know).

Adapting, being flexible and planning ahead of time with contingencies will be cornerstones to success and this is what I try to convey in related posts. The extent to which the country's balance sheet has deteriorated is beyond our control but the state of our own balance sheets doesn't have to be (I realize there will be those who disagree with me on this point). I continue to believe there is an endless number of solutions but finding them will take work.
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Sunday Morning Coffee

The passing of Steve Jobs among other things turned out to be a stop and reflect sort of event. Some of the quotes attributed to him about his personal philosophies were very interesting and add an entire different dimension to what I think about him (maybe I was the last to know). There were all sort of commentaries written of course but I'll cherry pick a couple that resonated with me from this one at MarketWatch which listed 12 lessons from Jobs

It's Not About The Money

I've said before that if you are doing something you love for work that the money will follow. It may not be a lot of money but it may not have to be (see below). The type of passion for a vocation that I think Jobs meant (and that I know I mean) will be manifested by superior output and be apparent to others. This can lead to some level of success or more humbly some level of viability. Making a living doing something you love to do is a great way to get on in life.

Yes You Can Make A Difference

Realistically none of us will make a difference that could be measured on a Jobsian scale but we don't have to make that type of difference. We can make small differences in our own circles of influence. Several times I've mentioned that you reading this and other stock market blogs are very possibly a go-to person for investing questions for friends and relatives. This may not even be a dozen people but if you helped one person avoid doing something truly stupid, then you made a big difference for that person even if they don't fully realize it.

Trying to make a difference plays a big part in my life but these are small scale. I can't express the amount of fun I have with my involvement with our fire department and while I like to think the fire department matters to the community it is not change the world stuff. But it doesn't have to be! It is fun and might make a small difference, not too shabby if you ask me.

Your Time is Precious-Don't Waste It

One odd nugget from all of this was the Steve Wozniak riff that Jobs always thought he would die young, in this context he lived a lot longer than he thought he would. I've mentioned this in terms of life being about the journey not the destination or not wishing every week away to get to the weekend.

My views here are shaped by personal experience. I was sick my junior year of highschool. Dying was unlikely, as I was told, but not impossible. This altered my life trajectory, at least I think it did in terms of what I would and would not have in my life and what I would do with my life. The various quotes attributed to Jobs about doing what you want to do with your life and last day on earth type of stuff is how I have structured my life.

To be clear I think I am going to be around for a very long time (good genes and I exercise a lot) but that does not mean that time is not precious. I started this phase of my career with two clients which means no money to speak of but my love of the work lead to viability and then a little better than viability (fortunately).

People have disagreed with me on this but the barriers to entry here are quite low as most of this is behavioral. Live in less house than you can afford, drive less car than you can afford, find something you love spending your time on, be willing to work your ass off in pursuit of the modest goal of viability and leave yourself a healthy margin of safety (low overhead, high savings rate).

This may seem preachy but I believe it is relevant to investing and portfolio management in terms of the burden we will place on our portfolios or the risks we need to take in our portfolios. We are more likely to continue doing work (that we get paid for) that we love later into life like my 80 year old neighbor and his backhoe and our portfolios will need to create less income if we continue to work and our needs are modest. How much better will your odds of financial success (IE not running out of money) if your portfolio doesn't have to start doing any heavy lifting until you're 80?
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The Big Picture for the Week of October 9, 2011

A reader left a question a couple of days ago asking my opinion on how to determine a market bottom. My thought process here will probably seem a little Hussmanesque.

I tend to think of this in terms of probabilities and whether or not the market gets the benefit of the doubt at a given moment. A contributing factor here is duration. Earlier in the week I saw a stat about bear markets lasting four hundred and something days and we were only 150 days in (by some measure). The exact numbers cited don't matter to me so much is the general understanding that bear markets last well over a year on average and we are only a few months in.

That assumes of course that we actually left the 2008 bear market and then had a bull market. My thought there has been that this will all be looked back upon as one big financial event and in late 2011 we are still in the middle of it. If I am wrong and we are in a normal bull bear cycle then based on averages there is still more time to go.

Either way I think we are still early in this bear phase. I would then look at two things to think a bottom is in; one related to time and one related to price. Five or six months from now I would be more inclined to give the market the benefit of the doubt than I would now. Among other things that might give the SPX' 200 DMA time to flatten out or turn higher or for the 50 DMA to cross back above the 200 DMA.

In terms of price, if there were a panic this month or next to something like SPX 800 (or some other level that might be relevant when we got there) would at least be a reason to deploy at least a little cash. A real panic is better to buy, although it is difficult to do. We bought a little into the Lehman panic in 2008 and a little in early 2009, before the low, but in hindsight we should have bought more.

The perspective here is more in line with my thoughts about targeting a result over the entire cycle as opposed to short term trades. Before the open on Tuesday with the SPX at about 1100 I commented that it would not be a shock if the SPX closed the week at 1200, and while it did not get that close it went up a lot, 1170 early in the day on Friday. That is still a pretty good lift for such a short period of time but unfortunately is not a sign of a healthy market hence I am not inclined to give the market the benefit of the doubt here.

The idea of the biggest up days occurring during bear markets is not something I came up with of course but something I have referred to often in this context because it seems to be pretty reliable.

I said I have been influenced by John Hussman on this subject but am generally willing to look more like the market than he is. I mention this as an example of taking bits of process from various sources to create your own process.
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Never Retire?

After a heavy news week, a couple of heavy blog posts and a bunch more equity volatility I thought a lighter post would be appropriate. I often try to make the point about finding some sort of work to do in retirement that you love to do and would otherwise do for free.

I found three examples of guys 80 or older do exactly that, getting paid to do something they would do for free. The first is Johnny Pesky who is 92 years old and still an instructor in the Red Sox minor league system.

Next is Don Zimmer who after being Joe Torre's bench coach has been on the Tampa Bay Rays staff for the last few years and still is on the field before every home game.

The last and most actively involved is 88 year old Red Schoendienst, special assistant to the general manager of the Cardinals but also he spends a lot of time evaluating minor league players.

A lot of people are interested in sports so being a bench coach or otherwise involved with professional baseball teams somewhere in the organization would seem to be fun work and probably would pay a couple of hundred thousand for maybe eight months of work, nine if the team goes far into the playoffs.

I've made this joke before but I think the point is valid and there are jobs available in every conceivable interest anyone of us might have. I think I mentioned that my wife's uncle was offered some sort of office work with the Angels that tied in with what he did before retiring.

The pay would have been low, I think he said $10 hour but games would have been free and it was part time. A few hundred bucks a month and all the baseball you want sounds pretty good, especially if the context does not have to be replacing some huge portion of your income. Some of these gigs might have benefits too (not sure if the job with the Angels had benefits or not).

In these types of posts I talk about spending time figuring out how to monetize a hobby (or interest). I'm not sure if coincidentally I've met a lot of people who have done this or if my belief in this concept somehow connects me to a lot of stories like this but the possibilities are infinite. If there is a way to monetize something you have done for years chances are you can figure out how to do that and then make it happen even if it takes a lot of effort.

I would not minimize the seemingly low pay either, or potentially low pay. Aside from the benefits of having something that you love that keeps you busy, a couple living on $3000-$5000 per month (a fine but not opulent lifestyle) who can make $400-$600, or more, per month part time can relieve a decent portion of the burden that might otherwise be placed on the portfolio.
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The Game is Rigged?

One byproduct of conversations like the one yesterday about the Occupy Wall Street protests is the sentiment that the stock market is rigged, that the little guy does not have a chance, that the individual investor cannot possibly compete.

This raises a couple of questions that are worth exploring.

If the stock market is rigged, when did this start? It is pretty obvious that to the extent it is rigged, the stock market has always been rigged. There have always been cheaters of one kind or another. We know this because every so often there is news of a cheater who gets caught. I don't think it is too much of a reach to think that not all the cheaters end up getting caught. What percentage of the cheaters do you suppose get caught? My hunch is it is pretty low.

The extent to which anyone thinks the deck is stacked against the individual investor it is no more or less stacked than it has always been. Yes participants who do have the advantages (whatever they may be) have better technology than they used to but so does everyone, on a relative basis. However much blame should be placed on HFT or algos, there is no denying that HFTs and algos spend more on technology than you or I. The predecessors to HFTs and algos have always spent more to acquire their edge (or if you prefer, unfair or even illegal advantage) than you or I or people like us ever did.

Whoever comes after HFTs and algos will spend more than we will. Again, any of this maybe unfair, unethical or illegal, or not but this is not something new. I don't remember these types of complaints back in the 1990s when stocks were all whizzing higher but there is no question that if there have been people taking some sort of unfair advantage over the last ten years, there were people doing the exact same thing in the 1990s. Remembers SOES bandits?

Greed is not new to Wall Street.

If you can accept that greed and unfairness (or if you prefer illegality) are not new then you have always participated along side of it. How has this impacted you thus far? It is unlikely that any of us could quantify how we have been affected. It is possible we haven't been directly affected. You can assume you were affected but I don't think there is a way to know concretely that any specific trade you placed was adversely affected.

Consider the chart to the left. It is a ten year chart that tracks VFINX in blue, Deere (DE) in green, Altria (MO) in orange and Chevron (CVX) in yellow. Whatever the reality of unfairness or cheating over the last ten years it did not prevent holders of the aforementioned stocks from trouncing the S&P 500 while having better than "normal" decades. While it would have been better to pay a split adjusted $19.86 than $19.93 (to make up an example with actual prices of where the stock traded that day) for Deere ten years ago, a $0.07 difference for a long term hold really doesn't mean much. Obviously it would mean a lot for someone looking to trade the stock for an hour or two looking for $0.20 or $0.30.

Looking forward, the unfair advantages will evolve and continue to exist. This will not prevent some stocks from being huge winners, some countries from thriving or some themes from paying off big for investors.

Rigged or not, if you plan to retire then you probably need some piece of money to be able to generate an income stream to fund your retirement. The decision for forgo potential growth available in global equity markets for any reason is perfectly valid but there are tradeoffs. If your money grows at 2% instead of 6 or 7% (or any numbers you think are realistic) and you want to retire at some point then you probably need to save more, work longer, live a more modest lifestyle in retirement or any combination of the three.

I tend to believe in solving my own problems before trying to solve the world's problems. That line of thinking draws criticism but I think the country would be better off if a larger portion of the population did this.

A quick comment on the passing of Steve Jobs; actually more like comments from other people. Jason Raznick from Benzinga tweeted "Jobs died at 56. Who in the world has accomplished so much in so little time?" Brian Sullivan from CNBC tweeted "There is no single device that brought me more joy than the ipod. Thank you, Steve Jobs, for bringing so much music to us all." Finally ETF Trends quoting Jobs who once said "Your time is limited so don't waste it living someone else's life."

And just to lighten the mood a little, I give you what is possibly the funniest picture ever posted on Facebook as captured by John Ramsay.
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What To Make Of Occupy Wall Street

I am trying to wrap my head around the Occupy Wall Street protests that have been going on lately and popping up in several other cities. The people I follow on Twitter have generally belittled the rallies and the message (whatever it might be) behind them.

There are no doubt a million different stories of why these people are engaged in the protests but it would not surprise me if many of the stories sound like this one from the WSJ;

"From 2006-2009 I owned a business with 12 employees," reads one, superimposed over a photo of a man and his young son, both smiling. "I closed my doors in 2009. I lost my home in 2010. I lived in my truck for six months. Now I rent a tiny room. I have no health insurance."

The last ten years have adversely affected many people, this is not news. There has been a lot of hard luck stories that have occurred (seems like more than normal) combined with events (failures) that we have not experienced before. Against that backdrop, the idea of asking some questions about what we believe is reasonable.

This is not to support their "Declaration" as there are things that would seem to not apply to Wall Street, the general leaning is much further to the left than where I land on just about any issue and I have also not been adversely affected by the financial crisis. As a quick timeout I am acutely aware of how lucky I am that the biggest hassle in my life is that my Saturday at the fire station where I volunteer was too long.

There is no way to know how many that have been disaffected were so because of their own actions or because they were somehow duped although human nature being what it is we can be sure that many people blame others. If my opinions about the economic fundamentals in the US and prospects for US market returns turn out to be anywhere close to correct then the group that perceives themselves as being disaffected will increase.

Josh Brown pointed out that the "protesters are winning." Some of the bigger financial stocks are down a lot since the protests started. Obviously they have generally been going down for years now but that does not change the fact that they are down a lot since the protest started.

Is there a social consciousness awakening because of the last ten years with Occupy Wall Street simply being the latest manifestation? If so, what are the ramifications for the rest of society? Will other demographic segments take to the streets, metaphorically or otherwise, to protest the unfair treatment they have endured?

I tend to believe that asking difficult questions is productive as is exploring other ideologies as a means for reaffirming your beliefs or as a catalyst to do things differently.

My own way of thinking might seem a little harsh but no one cares more about your own welfare than you do. Personally I have taken a couple of financial risks over the years with no expectation of a safety net provided by someone else.

When I was in college I had what I thought was a pretty sweet bicycle. I rode it to do an errand one day and it got stolen. Man, was I pissed off because it was my own fault. I was at a small store and thought it would be safe and I was wrong. A couple of days later I told my mother about it and she offered to pay for a replacement. This was my fault so I said no. Being brutally honest, the way I was raised, I should have taken the money for the bike, and while I do not know where this came from, the idea of taking the money was unacceptable. Family helped out with things when I was younger, but with something that was so clearly my screw up; I wouldn't have it.

While that was a long personal anecdote it sums up my belief that generally (there are always exceptions at both ends) we are accountable for our successes and failures which entitles us to enjoy the rewards or suffer the consequences. Trying to project one set of beliefs onto a group of people with a different set of beliefs tends to be useless as opposed to letting people draw their own conclusions. If we concede all the injustices cited by Occupy Wall Street (not my base case), there is not enough money to giveaway to fix it all--they would like all debt to be forgiven.

Sorry, I have no answers for society, only answers for myself.
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Market Update

"Wall Street took it on the chin, Monday." Any Simpsons aficionados know whether Kent Brockman ever said that on an episode? It seems like something he would say. I'm just trying to have a little fun and despite the graphic in the picture it is not time to panic.

Several times over the last couple of years after a nice little pop I commented along the lines that if you were freaked out and bargaining with yourself at SPX 700 or SPX 800 that you should take advantage of the (then) recent lift to sell some stock.

The idea back then was to envision, or better yet remember, your psychology from a past fast decline in order to avoid in a future fast decline like we are having now. I recently commented that at 1500 everyone knows the market goes down every now and then and everyone can tolerate the volatility. It becomes a different story a couple of hundred points lower but I would say it does not have to be if you have the right asset allocation.

We have current news about serious problems in Europe, with US banks, with a legacy airline and with an almost obsolete company (Kodak). What is your exposure there? Fortunately we have no ground zero exposure. We own things that are down a lot of course. Stock are arguably well along the road of pricing in a recession which means industrial and energy companies get hit hard.

I had a conversation over the weekend with someone who has a large position in a very cyclical stock and of course that stock is down a lot like many very cyclical stocks. I know a little something about the stock and made the observation that it seems to go down more than the market on the way down and then go up more than the market on the way up which was his observation too.

This is an important concept. The person knows ahead of time that if the market drops a lot, then this one name is very likely to go down more. I expect the very same thing with all of the cyclical stocks we own. I expect the defensive names will go down less and then go up less. Generally this is how it works and it is foreseeable. This is not about predicting what the stock market will do it is about understanding what your portfolio is likely to do if the market goes down or if it goes up.

When the above is combined with a little time spent figuring out what to avoid, financials and Europe may turn out to be the easiest avoids of our lifetimes, then you should be in position to endure this reasonably well. I've disclosed many time before that we own Nike (NKE). The company appears to be doing very well but the stock is still down. If a company is executing well even if the market is down then there is probably no reason to worry about it as a going concern.

I disclosed selling Caterpillar (CAT) earlier this year in the belief that we were headed into a recession and that heavy cyclicals get crushed during recessions. If this is a recession and bear market then I would expect CAT to bottom out with a about a 50% decline from its peak for the simple reason that this is what it has done time after time.

It is great when you can trade around that sort of decline but if you don't then you can take solace that most companies will come back and go on to new highs. CAT will go to $130 at some point even if it gets there by way of $60. This is not "permanent impairment of capital" although some of these financial stocks might be.

One last point to reiterate is that if you took defensive action along the way (we made several sales earlier on that I disclosed here) then you are probably thinking you should have taken more on a day like yesterday and if we close the week at SPX 1200 you will think you took too much defensive action. No one will trade this perfectly, but I would say if you can smooth it out some then you were successful. SPX 1200 by Friday might seem crazy but with the recent volatility it is not impossible. That is not a prediction and it would not be a sign of health either.
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