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We are traveling this weekend to Glenwood, MN, where my wife Cathleen was raised. The 54th annual Waterama festival on Lake Minnewaska is on and this charming little town at the beginning of lake country is buzzing with activities – not to mention assorted relatives, classmates and friends of Cathleen’s.  The parade down Main Street this afternoon had 100 entries including the Sons of Norway float, Shriners zipping around and festival queens from bigger places like Fergus Falls to tiny Clara City. I learned there are at least 12 different ways to wave from a float, including the “window washer”, the “polisher”, the “sig heil”, the “sweep”, the “sweep it under the rug”, the “traditional wrist flap” and “cupped-hand twist” among others. Garrison Keillor would have been proud of my observational skills. There was also a lighted pontoon parade on the lake, a pageant at the Lakeside Ballroom, dances, sporting events – lots to do. Waterama is a real slice of Americana. I’ve actually begun to look forward to my annual helping of green jello salad with veggies, fruit and creamed topping. So to accommodate my schedule, I am starting a little early on this issue. I am fortunate to be able to travel with more computing power in my briefcase than my entire office enjoyed just 10 years ago. Whether in my motor home, an airport or on the shore of beautiful Lake Minnewaska, I am always work-ready on the road. So, I’ll add a few market comments this weekend to keep the content timely, but in the mean time I’ll be vacationing a bit.
In This Issue…
Making Things HappenI’m a believer that you get what you think. If you think things are good they get better. If you think things are bad . . . well, you get the idea. The idea that every thought becomes a prayer fits in this category. Two weeks ago, I mentioned that this newsletter is becoming a sensation, and circulation is growing significantly. All I can figure is that my style of describing complex ideas from the financial arena in down to earth English appeals to a lot of you. But by declaring it a sensation, it became one in spades. On Monday, July 20th, Yahoo Finance reprinted an article from Kiplinger’s Magazine that quoted me, and things really got hopping at Hepburn Capital. We had 29 requests for information on Monday and Tuesday, alone. That is a LOT of interest in a little business like mine. Here is a link to the article if you would like to see what the fuss is about. http://finance.yahoo.com/focus-retirement/article/107353/can-you-time-the-market.html?mod=fidelity-buildingwealth Please forward this along to anyone you know who had poor investment results this past year and might benefit from the services of an active money manager. Thank you.
The Riddle of the Week What is black and white and red all over? (See answer below) Some Culprits Are Getting TheirsFinally the rating services are getting some heat. Many of the financial problems we have been battling for the past year or two were created due to the collaboration of the rating services which would put high ratings, often their highest rating, AAA, on complex securities that derive their value from other factors, which were often unknowable. These are called “derivatives”, in industry parlance. These AAA ratings were then trotted out by the hucksters who sold this garbage to unsuspecting pension funds, bankers and fund managers, who relied on the rating services to know what they are doing – which they didn’t. When history is written, I think a good portion of the blame for our financial problems will be assigned to the rating services who changed from disinterested third parties to active advisers to the promoters of these derivative investments – and collecting hefty fees for doing so. It sure seems to be a conflict of interest to me. The nation’s largest public pension fund has filed suit in California state court in connection with $1 billion in losses that it says were caused by “wildly inaccurate” credit ratings from the three leading ratings agencies. The suit from the California Public Employees Retirement System, or Calpers, is the latest sign of renewed scrutiny over the role that credit ratings agencies played in providing positive reports about risky securities issued during the subprime boom that have lost nearly all of their value. According to the Seeking Alpha news digest, the lawsuit, filed this month, is focused on a form of debt called structured investment vehicles, highly complex packages of securities made up of a variety of assets, including subprime mortgages. Calpers bought $1.3 billion of them in 2006; their prices collapsed in 2007 and 2008. Calpers maintains that in giving these packages of securities the agencies’ highest credit rating, the three top ratings agencies – Moody’s Investors Service, Standard & Poor’s and Fitch – “made negligent misrepresentation” to the pension fund. The AAA ratings given by the agencies “proved to be wildly inaccurate and unreasonably high,” according to the suit. The suit also contends that the ratings agencies continued to publicly promote structured investment vehicles even while beginning to downgrade them. Ten days after Moody’s had downgraded some securitized packages in 2007, it issued a report titled “Structured Investment Vehicles: An Oasis of Calm in the Subprime Maelstrom.” In the last issue of my newsletter, I wrote about problems I see with FDIC backing risky investments. These two subjects, FDIC and rating services are closely related as investors seeking to avoid risk rely heavily on both. It will be interesting to see how this issue plays out over the next few years as financial services regulation gets an overhaul. The Riddle AnswerIf you answered, an embarrassed skunk, a zebra painted red, a sunburned penguin or a newspaper, you are correct. Market and Account Updates The movement over the past two weeks has been so strong, that it is increasingly clear that the bull market that began in March is continuing on. The question is, what should an investor do to take advantage of it? I closed out our hedges (inverse investments that go up as a market goes down – “shorts”) about the time you were reading my last newsletter. Hedges can reduce market risk for us, but they introduce opportunity risk, the risk of missing a strong upward move in the market. There is no perfect way to invest, and one cannot avoid risk entirely, so the decision becomes which risk would I rather be exposed to in these circumstances? In times of great uncertainty, I will often choose opportunity risk over risk of principal loss. So although our growth strategies* have a small gain this month, we could have made more money if I had just stayed fully invested, the risk of the market breaking down was very high a few weeks back, and this kind of short-term underperformance is the price we active managers pay to achieve the kind of risk reduction that produces outperformance and lower risk overall. Our Careful Growth* strategy’s holdings as of July 24th include health care, utilities, international growth and Chinese stock funds, as well as high yield bond funds. I have a few more investments I want to buy, but we continue to hold about 1/3 of our growth portfolios in cash while I wait for a better entry point to do some more investing. When we get a dip in prices you will see our cash position get put to work. “Buy low” and all that. Our Flexible Income* accounts continue to be fully invested in high yield bonds. One of the hardest things for me is to do nothing when I see an indicator getting close to changing and not “jump my signals” trying to get a better price. Earlier this month we were within days of triggering a sell on high yields, but my patience has paid off and the strong gains in this sector are continuing. The Worst Appears over for Housing.I have given housing market updates once or twice a year for the past several years since my January 2005 warning that it was time to sell real estate unless you were prepared to hold it for a long time. For a guy who prefers to react to what the market is actually doing rather than try to predict what is often unknowable, I sure stuck my neck out earlier this year by saying after an ugly first half, the slide in housing prices should level off, and when low prices are combined with low interest rates, 2009 might just turn out to be the year of the bargain. I figured it was time for another update to see how I am doing. My comments are based upon the Case-Schiller Housing Index, which measures what investors think housing prices will do over the next 5 years in 20 metropolitan areas around the country. These numbers represent what big money interests believe will happen. There is no guarantee they are right, but the fact that they have so much money tells us they are right a lot more than they are wrong.
The Case-Schiller Housing Index shows that prices have fallen an average of 15.77% since last November. However, between August and November of this year, prices are expected to fall only another 2.31% on average across the country. Between November 2009 and November 2010 prices across the country are expected to fall only 3.66% for the entire year. Significantly, housing prices in Chicago, Las Vegas, Miami and San Diego are predicted to rise in 2010. That is certainly good news for homeowners in Las Vegas and Miami, two of the hardest hit areas in the country. Rebecca Wilder, author of the News-N-Economics blog reports that two other sources of data on housing prices, the FHFA and Loan Performance HPI, are showing stark improvements over the last 3 months with pricing declines moderating to only -5% and -3% annualized rates. Without boring you with details, both of these sources get data from broader geographical areas than the 20 city Case Schiller Index. The key is that all of these sources are saying the same thing. The worst appears to be over for housing prices. Now the question becomes, what kind of growth rate for the next 5, 10 or 20 years can be plugged in to real estate investor’s calculations? The jury is still out on that one.
2009 Fall Class ScheduleBasic Investing For Retirees Advanced Investment Analysis Using Charts For details or to register call Yavapai College 717-7755 |
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Will Hepburn is a well-known expert on investment analysis and portfolio management. Mr. Hepburn is president of Hepburn Capital Management, LLC, a Registered Investment Advisor, Chairman of the Board of NAAIM, the National Association of Active Investment Managers, and he is an instructor at Yavapai College in Prescott, AZ. |
CLASSICS
Here’s one of Will’s articles that has proven popular over the years.
Are CDs Safe? Safe from What? (3/3/09)
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Wise investors plan for what is likely to happen in the future and invest on that basis rather than on what happened last year. The relative stability of CDs make them attractive to investors worn down by the market turmoil of the last 18 months.
But, there are no investments that are safe from all risks, even CDs. So let’s take a look at what current circumstances are suggesting could possibly be in the future for CDs and what the risks might be in these seemingly benign investments.
Treasuries, CDs and other dollar denominated investments have clearly worked better than many investments over the past year or two. This is normal during economic contractions like we saw in 2008. But last year is not what makes you money in investing. In fact, studies1 have shown that investing in last year’s winners is risky and leads to under-performance.
So, although CDs, annuities and Treasury bonds have recently performed well, what might the future hold for them?
In recent months the US Government has committed to spend $3 Trillion before even getting to the really expensive issues of health care, social security reform and education or the normal cost of running the government. $3 Trillion extra. Where is all of that money to come from?
The government plans to borrow it. But who do you know with a spare trillion or two to loan to the government? The US has the largest economy in the world by far, and it can’t come up with that much money. The Chinese and the oil sheiks have big money, but not trillions, and each of them are deep in their own economic problems and are planning to spend much of what they do have in their local economies.
If the federal government can’t borrow the money, then it will have to print it. And printing money is a classic cause of inflation. CDs and other investments denominated in dollars can be devastated as the value of the dollars in them plummets due to inflation.
With the specter of inflation looming, I looked at history for some guidance of what might happen if the government resorts to printing large amounts of money to pay for its spending.
History is rife with the dictators of small countries printing money causing the value of their currency to collapse in what is called hyper-inflation. Bolivia in 1985, Argentina in 1990, and several African nations in recent memory.
It happened in Germany (1922-23), Hungary (1946) and in Russia (two times in the past 100 years.) and those were not third world countries. I have on the wall in my office a $2 billion ruble bond issued by the czar in 1916. $2 billion is now a just piece of wall paper.
Could it happen in the U.S.? The only thing that has me saying “no” is my nationalistic pride. The facts speak otherwise. So lets look at what happens when hyperinflation does occurr.
In all cases hyper-inflation arrives shockingly fast. Argentina had 5,000% inflation in 19892. A $2 loaf of bread in January cost $100 in December. A $100,000 CD bought in January was worth only $2,000 worth of groceries by December. Your $100,000 would have been returned to you, but with a loss of 98% of one’s purchasing power.
The number of dollars were safe, but most investors really want more. They want what the dollars will be able to provide.
In Germany in 19223, $100,000 put into the bank in May bought only $6,000 worth of goods by November, and was worthless a year later. It took a wheel barrow full of money to buy groceries in 1923 Germany.
When governments have their backs against the wall, economically, they always seem to choose inflation as the least painful solution. But least painful to whom? The decision makers, perhaps, but not savers.
No one knows exactly how our current situation will turn out, I hope I am wrong in worrying about this. But, I do know that politicians benefit from inflation. It is the easiest way to wipe out the huge debts the government is amassing. However the real value of savings gets wiped out too, including CDs, annuities or bonds. Anything with a face value quoted in dollars would be at risk from inflation.
Investors planning to seek safety of CDs or annuities need to be mindful of the lesson I tried to impress upon students in my Yavapai College class for almost 20 years now, When someone says the word “safe” to you, your response should be “safe from what?”
Some folks think dollar denominated assets such as CDs, bonds and annuities may be safe, but safe from what? They may be safer from market risk and default risk than many other investments, but their big risk is from inflation.
The key to protecting one’s investments during inflation is to not be a lender. When you buy a CD you are loaning your money to the bank.
What is an investor to do? As always, I would advise you to stay flexible and diversify, diversify, diversify. Never have all of your assets in any one investment class, like dollar denominated investments that can all be affected by the same risk.
The assets that traditionally do best in inflationary times are hard assets – things you can touch and feel – things that are not denominated in dollars – such as oil, precious metals or real estate. Some investors seek to avoid inflation risk in foreign denominated bonds and CDs (if – a big if – that country does not also suffer inflation).
Investments that will fare the worst during inflation will be dollar denominated investments such as CDs, annuities and bonds that are to be repaid in dollars that might become worth less (potentially a lot less) before the maturity of the investment.
So before you go loading up on certain investments because you think they are safe, remember to ask “safe from what?” and make sure you are protected from those pesky other risks out there.
Don’t let your savings become wall paper.
1. A March 2004 study at the University of Cologne in Germany, “Family Matters: The Performance Flow Relationship in the Mutual Fund Industry” as reported in investopedia.com. Also a study, by Christopher R. Blake, associate professor of finance at Fordham University’s Graduate School of Business, and Matthew Morey, assistant professor of economics at Fordham reported by Mark Hulbert in the NY Times April 4, 1999.
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* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.
** The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market. Investors cannot invest directly in the S&P 500 Index.
