European Troubles Starting to Hit U.S. Shores

It seems like forever since I started talking about Europe and their debt crisis.  It's taken awhile, but their problems are now starting to affect the U.S.

In Good News From Europe, Though I Have Trouble Seeing It, I stated that Eurozone spending accounts for 41% of S&P 500 revenue.  During the earnings pre-announcement season, I noted one company that I follow blamed failure to close a few large deals in Europe for their earnings warning.  Now with Q1 results being reported, we learn that IBM and Intel are having trouble in Europe as well.  From Bloomberg, Intel, IBM See Sales Stall as Europe Crisis Crimps Orders

Intel Corp. (INTC) and International Business Machines Corp. (IBM), computer-industry bellwethers, posted the slowest sales growth in more than two years last quarter as the European slump weighed on orders. 

IBM’s revenue climbed 0.3 percent to $24.7 billion in the period, while Intel sales rose 0.5 percent to $12.9 billion. That was the smallest increase for either company since the third quarter of 2009, when the U.S. economy was just emerging from recession. Even so, Intel predicted a pickup in sales for the current quarter. 

The two technology giants are seeking growth in emerging markets while coping with a slowdown triggered by the European debt crisis. The personal-computer market, which contracted in the U.S. last year for the first time since 2001, also is hurting demand for Intel’s processors. IBM, meanwhile, is more focused on expanding earnings per share, rather than pursuing less-profitable orders.

The question now is this a one time event like Intel believes or the beginning of a new trend.  Looking at Europe, I'm not optimistic.  From the Telegraph, Debt Crisis: as it happened, April 18, 2012

14.03 Italy has cut its 2012 economic growth forecast and moved the goalposts on its balanced budget rule.

The Italian economy is now expected to contract by 1.2pc this year from 0.4pc previously, The revision was largely expected, following a series of leaked reports in the media. 

The Italian government, which had vowed to balance the budget in 2013, now expects a shortfall of 0.5pc of GDP next year, and a balanced budget in 2014. In a statement, the Italian government said:

Despite the progress made, there is still a long way to go in a context that is more favourable but still characterised by elements of uncertainty.

Analysts that I've read have been optimistic on Italy because it does not have a budget deficit.  However with the third largest national debt load after Japan and the US, a shrinking economy threatens to overwhelm it's ability to pay back its debts.   Additionally, analysts were also hoping that Prime Minister Mario Monti would be successful in reforming Italian labor laws in the hope of making them more flexible.  After months of negotiating, it appears that optimism may have been misplaced as labor unions do not want to change the status quo.

Moving on to Spain, it has been some time ago when Spain announced that they would not reduce their budget deficit to 3.5% of GDP this year.  After what were surely some intense conversations, Spain agreed to target a 5.3% deficit.

Eurozone is Trending Down

In the U.S., car sales are one quick means to measure how consumers feel.  I'm was not sure this applies in Europe too, but Bloomberg recently dispelled any qualms I had with this headline, European Car Sales Fall to 14-Year Low as Economy Stalls (emphasis mine)

European car sales fell to a 14- year low last month, with Fiat SpA (F), Renault SA (RNO) and PSA Peugeot Citroen (UG) posting the biggest drops, as the region’s sovereign- debt crisis caused economic growth to stall. 

Registrations in the 27-member European Union plus Switzerland, Norway and Iceland fell 6.6 percent from a year earlier to 1.5 million vehicles, the lowest figure for March since 1998, the Brussels-based European Automobile Manufacturers’ Association said today in a statement. First- quarter sales dropped 7.3 percent to 3.43 million vehicles. 

France and Italy, Europe’s second- and third-biggest auto markets, shrank by more than 20 percent. The regional drop was alleviated by growth at German carmakers, such as Volkswagen AG. (VOW) Paris-based Peugeot is among auto manufacturers forecasting an industrywide contraction of 5 percent in Europe this year. 

“The extent of the beat for Germans is a bit surprising, as well as the extent of the downturn for the French,” Adam Hull, a London-based analyst at WestLB AG, said by phone. 

French car sales plummeted 23 percent to 197,774 vehicles, while Italian registrations dropped 27 percent to 138,137, according to the association, or ACEA.

The bolded items caught my eye.  If people don't want to buy big ticket items due to uncertainty, its understandable that companies are uncertain too.  I will continue to watch the reports from other companies to see if this is simply the beginning.


Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

Talking the Talk, They will Walk the Walk

You can talk the talk. Do you walk the walk?
- Full Metal Jacket

Well it didn't take to long for things to get dicey again in Europe.  Even though Greece was restructured 3 weeks ago, and the ECB lent ~$1 Trillion of LTRO funds, bond rates in Italy and Spain are climbing higher.  On March 1, the 10 year Spanish bond was 4.87%.  Today Spanish rates hit 6%.  This is important because as the 10 year bond moves towards 7%, it means investors have lost confidence the Spain can resolve its budget deficit and make good on its debts.  7% is the line in the sand as this is when Greece, Ireland and Portugal needed bailouts.

Source: Bloomberg

Almost on cue, the ECB restarts talk about it's bond buying program.  From the Telegraph: ECB may act to bring down Spanish borrowing costs

Benoit Coeure, an executive director of the ECB, said the bank could restart its sovereign bond buying programme in a move likely to antagonize Germany but relieve a spiralling political, economic and social crisis in Spain.

Mr Coeure said that market fears over Spain were "not justified" but he added: "Will the ECB intervene? We have an instrument, the securities markets programme [SMP] which hasn't been used recently but it still exists."

Bond traders were soothed by the comments. The yield on Spain's benchmark 10-year bonds was pulled back from 6pc on Tuesday to 5.88pc, while the yield on Italy's 10-year debt also dropped marginally, to 5.54pc. 

Mr Rajoy delivered a strongly-worded speech to parliament insisting that it was "as clear as day" that Spain would not need a Greek-style bail-out.

Occasionally I'm asked how did I know things were going to blow-up in 2007.  My first clue was when the word "contained" was used by Ben Bernanke and Hank Paulson with regard to subprime mortgages.  Mike Mish Shedlock shred those claims to pieces using examples of Washington Mutual mortgages.  Another clue came from Paulson's claim that the US would not need to take over Fannie Mae and Freddie Mac.  When things are officially denied like that, watch out because it's going to happen.

Rajoy is right in that Spain will not need a Greek-style bailout - it's going to need a Spanish-style bailout because Spain's economy is more than double the size of Greece, Portugal, and Ireland combined.

We've Seen This Movie Before

The movie I refer to is how the ECB, IMF, and EU treated Greece's fiscal problems.  Currently Spain is sticking to cutting its budget though I've read that the EU wants it to raise taxes as well.  I expect to hear more about selling national assets to pay down debt.  When the ECB starts buying more Spanish bonds, then start to watch Spanish banks as they are reported to have been buying Spanish bonds using the LTRO money.  As these bonds have dropped in price, the losses to banks are building.  Worse if there is a Spanish restructuring, remember that the ECB gets paid in full while investors and banks get shellacked.

The only way Spain does not get bailed out is if it leaves the EU first.  What are the odds the politicians go that route?

And in the U.S.

The one direct affect of Spain should be falling bond rates in the U.S. as investors seek a place of refuge.  Ironically when bonds rates rose a few weeks ago, I wondered if people had forgotten that the LTRO in Europe simply bought time - it didn't solve anything.  Maybe most people thought it bought 3 years of time.  Regardless, bond rates in the U.S. should stay lower as questions about Europe and questions of the U.S.'s recovery remain in focus.

And about that U.S. recovery, it seems the best we can get is conflicting data.  What I might find humorous, if it wasn't so maddening, is how the good data took hopes of a new quantitative easing program off the table - but then unexpected bad data (in the form of the March employment numbers) immediately raised the hopes for such a program again.  The reason I, as a stay-at-home dad, find this maddening is that it resembles my two year old's temper tantrums.  Give us QE3 or watch the stock market tank.

What's worse is I see the Fed giving in as they have every time the stock market threatened to fall.  From Advisor Perspectives: Fed Intervention and the Market

I'm not the only one who sees the Fed giving in.  From Bloomberg: Gross Cuts Treasuries, Raises Mortgages in Fed Buy Bet

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., cut holdings of Treasuries last month to 32 percent, the lowest since December, and raised mortgages to the most since 2009.

Gross reduced the proportion of U.S. government and Treasury debt in the $252.4 billion Total Return Fund in March from 37 percent of assets in February, according to a report on the company’s website today.

Bill Gross, co-chief investment officer of Pacific Investment Management Co. (PIMCO), speaks during an alumni event hosted by UCLA Anderson School of Management in Beverly Hills on Nov. 17, 2011. Photographer: Andrew Harrer/Bloomberg

He raised the fund’s holdings of mortgages to 53 percent last month, the highest since June 2009, from 52 percent in February, in a bet that the Federal Reserve will buy the securities in a new round of purchases. Newport Beach, California-based Pimco doesn’t comment directly on monthly changes in its portfolio holdings.

The Fed will probably shift focus to buying mortgage securities to keep borrowing rates low when its so-called Operation Twist program ends in June, Gross said in a March 28 interview on Bloomberg Television’s “InBusiness with Margaret Brennan.”

Bill Gross successfully front ran previous Fed easing, meaning he bought treasuries and mortgages at a lower price to sell them to the Fed at a higher price.  Can it work again?  As the Fed has consistently talked the talk and walked the walk, I wouldn't bet against it.

Parting Thoughts

I've read recently that you have to trade (invest) the market you have, not the market that you want.  It made me think if I ever have invested in a market that I want.  Thinking back to when I got started in 1998, that was the final legs of the Internet bubble.  Afterwards, the Federal Reserve slashed rates so low and kept them there so long, that the housing bubble formed and kicked off the debt crisis.  Now global central banks are printing trillions in an effort to get things back to normal.

However what is normal? Looking back, it seems that all I have experienced in financial markets is managed by interest rate setting central bankers. When do bond markets finally say "enough" and start selling (thus raising interest rates)?

Perhaps what I really need to answer is what would make me sell my bond mutual funds.  Quantitative easing 3?  More Congressional stimulus? More tax cuts without offsetting spending cuts?  Maybe even no spending cuts?  More government borrowing?

As it is late, I'm going to let these questions go unanswered though I have a bunch of thoughts swirling through my head.


Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

Where the Economy is Headed - A Different Perspective

For many years now, my father has told me to watch the baby boomers.  Look at what this large population segment wants and needs - invest in that, build a business model around that he would tell me.  Considering that individuals born between 1946-1964 number approximately 77 million, baby boomers account for practically 25% of the US population.  Indeed if you can find an idea that resonates with this group, your idea would pay off very handsomely.

Yet the reason I've been thinking about the baby boomers recently isn't because of some new investment idea.  Far from it, I keep coming back to the article Worthwhile From the Web: Thoughts on Retirement with Dignity 2.0.  A quick refresher:

Entitled Thoughts on Retirement with Dignity 2.0, the author reviews these baby boomers backgrounds, prospects for retirement, options in achieving retirement, and implications on the economy. Here's a preview: 

The 80th percentile 57 year old household income is little changed from 2 years ago (or 4 years ago, for that matter) and stands at $150,000. They have, on average, a $200,000 mortgage on a home valued in the low $300 thousands. (The value was $370,000 in 2007). If they have a 401K or IRA, the balance is approximately $100,000. ...

Only $100,000 saved? If you haven't read this article before, it gets better. Taking into account other assets and liabilities, this particular subset of baby boomers are $100,000 in the hole. After reading this short excerpt, I think what a baby boomer needs is a realistic retirement plan. Fortunately, the article lays out what is needed:

I came up with 3 primary actions that can be taken in order for these 57 year olds to retire comfortably, if taken together. All of them will have a potentially negative impact on the economy.
1. Postpone retirement to age 70 or older
2. Cut the household budget and save the difference
3. Liquidate debt by downsizing
...
They need to take the $115,000 in spending down to, say, $75,000. Talk about choking the horse. But it certainly can be done. That will facilitate $40,000 in annual savings, but what is really cool is that, after adapting to the pain of austerity and establishing a less expensive lifestyle, the savings goal drops to $1,080,000! 

Did you catch the most important point?  Here it is again: All of them will have a potentially negative impact on the economy.  Let's review a few potential consequences of these actions.

By postponing retirement to age 70 or older, I foresee an impact on college graduates because fewer jobs are available.  Without good jobs, these individuals will struggle to start their lives.  Indeed, how can we expect these individuals to buy a starter home when they're trying to pay off college loans from a minimum wage job?  Postponing retirement works for those baby boomers, but negatively impacts the next generation of workers.

Cutting the household budget and saving more leads to less growth, or worse, a contraction in the economy.  If there's less growth, that means less job opportunities.  In a contraction, layoffs may follow as companies strive to remain profitable.

Liquidating debt by downsizing their home is another option, but it comes during the largest housing slump since the Great Depression. Thanks to postponing retirement, baby boomers limit the number of starter home buyers in the market.  Additionally these buyers need a 20% downpayment in order to qualify for a mortgage.  Furthermore this leads to a dearth of move-up buyers who cannot buy until they sell their current home.  Finally with more foreclosures projected to come on to the market, home prices can best be expected to stagnate due to an increase in supply.

Looking at All Baby Boomers

Even though the above article zeros in on 80th percentile 57 year old baby boomer, the three actions apply to all baby boomers.  This made me wonder about the overall retirement readiness of this generation.  I found the 2012 Retirement Confidence Survey from the Employee Benefit Research Institute.

A few quotes from this report:

... nearly a third of older workers reported savings and investments of less than $10,000.  

Despite approaching retirement age, half of workers age 45 and older have not tried to calculate how much money they will need to have saved so that they can live comfortably in retirement. 

Workers of all ages appear to be planning to retire later, on average, than similarly aged workers were in 2002. In particular, the percentage planning to retire at age 66 or older has increased significantly for every age group.

The decline in confidence about having enough money to live comfortably in retirement is statistically significant across all age groups between 2001–2011.  

Workers age 55 and older are more likely than younger workers to be very confident that Social Security will continue to provide benefits of at least equal value to the benefits received by retirees today.

Peak Spending

I've been watching the stock market continue to rise since October wondering what does it see that I am missing.  I found myself questioning my own logic as I read reports of the growing economy.  However, I still believe that the headwinds that the US and world economy face are present.

Baby boomers are not ready for retirement. They need to curtail their spending and save more. Thus baby boomers are not going to aid economic recovery by going on a shopping spree.  Indeed Doug Short from Advisor Perspectives agrees in his article, Demographic Headwinds for Economy and Markets: The Decline of Peak Spenders.

Demographer Harry Dent was recently a featured guest on Bloomberg TV in an interview that was promoted with the frightening tease "S&P 500 to Fall 30-50% in 2012." The video clip is available at YouTube here.

The rationale for Dent's grim forecast is primarily based on the demographics of the peak spending years, an age cohort he refers to in the interview as ages 46 to 50. If we use the Census bureau five-year data groupings, the cohort in question is Age 45-49 (which is the range Dent normally refers to in his publications).

...

Let's study a graph of the Census Bureau historical and forecast data for the peak-spending cohort population in the US from 1980 to 2050.

With baby boomers now exiting their peak spending years, the economic ramifications are going to be felt for many years into the future. The Census Bureau doesn't see growth in peak spenders resuming until 2022.  When I read analysts saying that the US cannot experience a stagnant economy like Japan, I wonder why not.

I encourage you to click the link to the above article as there is a PDF file that provides the buying habits of different age groups.

Parting Thoughts

As it's getting late, I'm going to wrap up by saying it's tough sticking with a plan while the market is doing the exact opposite of said plan.  Still when analysts (like Goldman Sachs a few weeks ago) talk about this is the best time to buy stocks in 30 years, it's critical to look at the picture from every angle.  I think the economy can and will muddle through (to borrow a phrase from John Mauldin), but that's not the same as a legitimate secular bull market.

From the perspective of what baby boomers need and how it impacts the economy, caution is called for in today's markets.


Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

Are We in a Cyclical Bull Market Within a Secular Consolidation?

Secular (adjective) - in economics, occurring or persisting over an indefinitely long period.

With stock markets around the world continuing to rally, it seems that the all clear has been sounded.  Indeed yesterday in response to JP Morgan announcing a dividend hike, the Federal Reserve announced the results of the another round of bank stress tests.  Out of 19 banks, only four failed what seems to be a pretty dire scenario:

• 13% unemployment
• 50% drop in stock prices
• 21% further decline in housing prices

To fail meant that the bank had less than a 5% capital ratio, which means the bank is not well insulated to losses.  Stocks rallied to new highs.  In response to another positive Fed report on the economy, bonds have fallen rapidly as investors see far better that 2% yields in the stock market.

Life is good again.  Or is it?  It's during this time that I feel it's necessary to look at the big picture.

• Greece's 2nd bailout for €130 billion was approved after the successful debt-swap where approximately €200 billion of bonds were swapped with new bonds worth €100 billion.  So net-net, the Greeks are €30 billion more in the hole.
• Spain agreed with the EU to meet a 5.3% deficit target instead of a unilaterally announced 5.8% target.  Originally Spain's deficit target for 2012 was 4.4%.  Spain's deficit was 8.5% in 2011.  In response, Spain's 10 year bond yield is rising again though at 5.17% it's not in danger territory yet.
• Portugal's ten year bond yield is 13.72%, so don't fall into the trap thinking that Greece will be the only EU country to default.
• Debts in other European countries remain.  Additionally these countries will need to fund their contributions to the European Stability Mechanism (ESM).  See To the Moon and Back.
• China announced it would target GDP of 7.5% instead of 8%.  For Australia, Brazil, or Canada, which export commodities to China, this is cause for concern.  Additionally, China has been remarkable in achieving steady high returns over the years. The last time I saw such consistency with returns, people didn't think anything was strange about it either, until the floor fell out from under Bernie Madoff. 

Furthermore nothing has changed in the US regarding debt levels or a political solution to future entitlement liabilities.

While I believe that the economy has improved, how much has really changed?  In my mind, nothing has really changed.  Thus I have trouble seeing the current stock rally as anything other than a cyclical bull market within a secular consolidation.  What is a cyclical bull market? If you answered (or guessed) a bull market that lasts a few years, you are correct.  The last cyclical bull market started 2002/2003 and ran until 2007.  

In addition to cyclical bull markets, cyclical bear markets also exist.  Cyclical simply denotes a market trend that is shorter than a secular trend.  As shown on the picture below courtesy of my friends from Tesseract Asset Management (please note that the orange and green comments are mine), cyclical trends last a few years.  You can easily distinguish 2 cyclical bear markets and 2 cyclical bull markets since 2000.

Source: Tesseract Asset Management

Falling back on the 100 Year Market Theory from Kevin Tuttle, stocks are overvalued if the 10 year moving average Price/Earnings ratio is greater than 22 (see also  Market Risk, Are You Managing It?). The current cyclical bull market has pushed up the market's P/E.  http://www.multpl.com/ lists the today's P/E at 23.25. 

Illustrated on the full 100 Year Market Theory chart below, we find that P/E ratios can certainly go much higher than 22.  However, secular bull markets do not start until P/E has reached 10 or less.  We're not there still.

The chart also illustrates another interesting occurrence, secular bull markets and secular consolidations take a similar amount of time to run their course.  Should this remain true, it means we still have a few more years until the next secular bull market starts.

Source: Tesseract Asset Management

What Does this Mean for Me

If you're have a Dollar Cost Average portfolio, hopefully you learned something new. It is a rare that I change anything in my wife's 401k throughout the course of a year.

For my Retiree portfolio, I'm staying the course as I think there is still at least as good of chance for the market to fall as to rise.  

Parting Thoughts

One interesting fact I found on http://www.multpl.com/ was the P/E for the Black Monday crash in October 1987 was ~17.5, which means that bad things can occur when investors assume a lower level of risk.  I'm not saying that a one day market crash like that will happen, or even can happen considering the rules put into place since that day.  I'm just saying that I found it interesting... 

Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

Musings on the Market March 11

Quite often when I write, I feel like I need to say something about time horizon.  If you're a long term investor, you really don't need to focus on the daily news (except my blog of course...).  Now if you have an ADD-like complex where you have to monitor all things financial and economic, welcome to my world.  Please note though that I rarely make changes to my long term allocations based upon news events.

On the One Hand

I've been reflecting on all of the news from last week, trying to assign some importance to the news compared to the risks that I've talked about in past articles.  We saw encouraging news:

• Labor Department says 227,000 new jobs in February plus December and January were revised up by 61,000.
• Manufacturing and Service ISM numbers are still showing expansion.
• German exports increased 2.3% in January versus December.
• French industrial production increased 0.3% in January versus December.
• Greece successfully swapped it's debt.
• The Greek debt swap was called a default for credit default swaps (CDS) because of the use of collective action clauses (CAC) to bring bond holder participation to needed levels.

New jobs means that the economy is trying to recover.  Likewise, expansion in the ISM numbers also portends to an economy trying to mend itself.

The German and French reports are important because those are the largest two economies in Europe.  If there is any hope for Europe to get through its problems, its best players need to perform.

The Greek news was encouraging because finally the EU is starting to see that they have to restructure and/or default on debt in order to get through the problem.  The other positive is that the committee that rules on defaults for CDS declared a default event had occurred.  I'm not sure any bank would have ever sold another CDS contract had that not happened.  Furthermore, who would buy sovereign debt in troubled countries if they cannot hedge their risk?

On the Other Hand

There was also conflicting data:

• US productivity was down significantly for all 2011 compared to 2010. 0.4% vs. 4.1% respectively.
• Unit labor cost, which includes wages, was up 2.8%.
• The Federal Reserve is weighing a new method of easing to keep rates low.
• The Greek debt swap was called a default for credit default swaps (CDS) because of the use of collective action clauses (CAC) to bring bond holder participation to needed levels.

Declining productivity can be attributed to many things.  As employment is rising, I consider declining productivity to be the result of new workers added to payrolls - they take longer to complete their tasks.  New workers would also explain why unit labor costs are also rising. The reason this is important though is it should lead to rising prices.  Rising prices would cause the Federal Reserve to reconsider their easy monetary policy.

A little more on the Federal Reserve, I especially like how the announcement of their "new idea" came out the day before the Greek debt swap.  As any type of new easing program is widely thought of as positive, it breathed life into markets that were looking for a new hope to cling to now that the second Long Term Refinancing Operation in Europe is completed.

Another thought on easing, if things are recovering, then why do we need more?

The Greek news was also discouraging.  From John Mauldin's Thoughts from the Frontline: There Will Be Contagion (emphasis mine)

Greece itself is in free fall. The "benefits" of austerity have not become apparent, as the Greek economy saw growth rates of -0.2% in 2008, -3.3% in 2009, -3.4% in 2010, -6.9% in 2011, and...? The 4th quarter of last year saw a GDP fall of 7.5%. Do you see a trend here? The Greek economy is down by almost one-fifth in less than five years. Unemployment has risen to 20%, and 50% among young people, many of whom are leaving the country. Resentment has grown among ordinary Greeks over the austerity medicine ordered by international creditors, which has compounded the pain. Greek papers are full of stories blaming Germany for their problems. 

By any standard, what will soon be a 20% drop can be classified as a depression. There is nothing on the horizon to suggest things will turn around any time soon. The country's public debt-to-GDP ratio currently stands at 160% of nominal gross domestic product, AFTER the debt restructuring. If Greece can find someone to lend them more money, it will only get worse. 

The current agreement with the EU will not improve the economy, but require even more wage cuts, government spending cuts, and higher taxes and unemployment. The problem is that if Greece leaves the euro, those problems do not go away, they just take a different form. There is still a great deal of economic pain for Greece as a consequence of past decisions. It is sad, but there is no other choice, unless the rest of Europe or the world, through the IMF, simply gives Greece all the money they want. But then where do you stop?

As John mentions, did you see the trend of weakening GDP?  The only way for Greece to lower it's debt-to-GDP ratio is to cut spending and grow it's economy.  The growth doesn't look promising.

By the way, John's letter is worth your time to read in full. These letters are free and you can sign up at www.johnmauldin.com.

Finally, have you ever played a game where someone tried to change the rules well after that game had started?  If you have an ultra-competitive 5 year old in your midst, you are undoubtedly nodding in agreement.  The Greek debt swap was also a negative because the CACs were added to law AFTER the bond contracts were already written.  So in addition to watching the ECB get paid in full on it's bonds, investors were forced to take their losses even if they tried to hold out.

Which leads me to my next thought - what's preventing this same routine of investing in sovereign debt, having a CAC inserted into law, and then forcing a default as part of additional bail outs from being used on other countries?

So What's This Mean to Me

I honestly do not see anything that requires me to make any changes to either my Retiree Portfolio or Dollar Cost Averaging Portfolio.  Every time I see encouraging news, I start to feel like I may miss out on something in my Retiree Portfolio.  However I then remember that nothing has really changed the overall debt picture.  Yes things look good, but as I said above, if things look so good, then why is the Fed looking to ease more?  And why is the ECB lending out more money just to cover payments of previously borrowed money?

Parting Thoughts

It's spring break, and for once in Texas, I think it'll be rather nice outside.  So far, 2012 has been warmer than I remember in years past.  And we're finally getting some ugh needed rain.  Hopefully that will continue.  If you haven't been to Texas in mid-March, let me simply say that the weather is anything but predictable. I've been on fishing trips where we've gone from sunny and 80 to cloudy, rainy, windy, and in the 40s.  Definitely not predictable.

However since my kids are out of preschool, my schedule will be predictable - predictably busy.  Still I'm hoping to discuss the 100 Year Theory Chart again, which was first revealed in Market Risk, Are You Managing It?.  I hope you have a great week!


Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

You've Got to be Kidding Me

Fool me once, shame on you.

Fool me twice, shame on me.
- unknown

If I had a nickel for every time that I could use that quote in talking about Europe's problems, the U.S. Mint would lose some serious money.  From Coin Update: Cost to Make Penny and Nickel Rises, Annual Loss Reaches $116.7 Million (emphasis mine)

The cost for the United States Mint to produce and distribute the cent and nickel rose to their highest levels, and are now more than double the respective face values. For the fiscal year ending September 30, 2011, the unit cost for the cent was 2.41 cents and the cost for the nickel was 11.18 cents.

Yet the winner in the category of You've Got to be Kidding Me, from Marketwatch: ECB to again accept Greek bonds as collateral

The European Central Bank on Thursday said it would again accept Greek government bonds as collateral in its funding operations. The bonds had been ruled temporarily ineligible for use as collateral last month after Standard & Poor's declared Greece to be in selective default. The ECB said at the time that eligibility would be restored once a previously-agreed collateral enhancement program for Greece was formally activated.

Seriously?  The results of the Greek debt swap haven't even been announced yet.  In case you didn't know, the deadline to exchange ~€200 billion Greek bonds for new bonds that retain around 30% of the original value was today.  Why would anyone do that?  Because in order to qualify for their second bailout, Greece held a gun to their debtors's heads and said 30% or 0%, take your pick.  

The biggest irony though is that the ECB received a special bond swap that paid out 100%.  What are the odds that the ECB takes a loss on any future debt swap?  The ECB will take payment in full again.  

Even better, the second bailout hasn't been paid, but there's already talk of a third bailout.  From Der Spiegel: Merkel's Government Divided over ESM Demands

Demands from abroad to increase the size of the euro bailout fund have put Chancellor Merkel in a difficult position, caught between international pressure and domestic demands. Even worse, the troika monitoring Greece's financial situation believes that a third bailout package may become necessary within a mere three years.

When is it ever going to end?  It's said that Albert Einstein said insanity is doing the same thing over and over again, but expecting a different result.  It'll be interesting to see if common sense prevails as Portugal (and possibly Spain) are next.

In some ways, the Greek debt exchange is a necessary first step.  I often write that debt can only be retired through three means - by repaying it, restructuring it, or defaulting upon it.  Finally, debt is being "defaulted" upon - even if it is "voluntary".  

Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

Retiree Portfolio and Dollar Cost Averaging Portfolio

Offense wins games, defense wins championships.
- unknown

While we're sure to trip at times, the goal is not to fall.
- Todd Harrison


I've been debating today's topic for a few days now.  My main worry is not that the topic is controversial, but whether I can clearly articulate my point-of-view.  So with the caveat that these are my views based upon my risk tolerance, my time horizon, my investment objectives, and my desire to sleep at night, it's time to introduce the two portfolio's I commonly write about:

1. Retiree portfolio
2. Dollar Cost Averaging portfolio

As I cannot assume that everyone has read my previous articles, a little background on me from Maybe I'm Not a Lazy Investor:

I graduated college in the late 90s to a job with an S&P 500 software firm. Among my benefits was a 401k retirement plan with a generous company match of 50 cents on the dollar up to ten percent of my salary. Knowing a good thing when I saw it, I immediately enrolled into the 401k program for ten percent of my salary. After reading a few investment articles and talking to family and friends, I selected 4-5 stock mutual funds to diversify my fledgling nest egg. My primary screen was fund performance and low cost. 

Over the initial years, I have to admit a gratifying satisfaction watching my account balance rise with the stock market. I took up finance and economics as a minor hobby reading the occasional magazine article and watching CNBC. As with much of the nation, I was enamored with the idea of striking it rich in technology or Internet stocks. 

However this joy came to an end that I never saw coming. In March 2000, people decided that companies should earn a profit and not simply count how many eyeballs look at them daily. Over the next several months, the stock market crashed and so did my 401k. 

During this time, I did what I was supposed to do. I kept on buying, which dollar-cost averaged my nest egg into cheaper shares. Still, that didn't take the pain away. I decided that I needed to learn how to look for warning signs of future market crashes, as well as learn from my mistakes - such as not having diversified into a bond fund those initial years, which would have significantly cushioned the blow.  

...

October 2007 was a notable month as I decided to move on from the same software company to the position of stay-at-home dad. It was also notable as I couldn't get my retirement money out of the 401k plan and into a rollover IRA at Vanguard fast enough. While you might think I was in a hurry because Vanguard invented the low cost index mutual fund, you would be wrong. 

Since the Nasdaq Crash of 2000, I had become a voracious reader of economic and financial subjects. 

... 

This time I saw the financial storm on the horizon known as the US housing crisis, and I was determined to save my hard earned retirement nest egg.

The Genesis of My Retiree Portfolio

I am a huge proponent of dollar cost averaging.  The primary advantage of dollar cost averaging is buying more shares at lower prices should the stock market drop.

However being a stay-at-home dad, I no longer dollar cost average into my 401k as I have no income.  In this respect, my 401k resembles a portfolio of a retired individual, which is why I call it my Retiree Portfolio.  And like a retired person, my primary objective for this portfolio is capital preservation - I don't want to lose a lot of money if there is a foreseeable crisis.

Although I'm a proponent of lazy investing, I saw no reason to let the storm known as the 2008 Financial Crisis decimate my retiree portfolio.  So I tried to protect the portfolio from losses as best as this engineer-want-to-be-investor could by managing risk. Thus what you see in the table below are my Retiree Portfolio allocations.

 Table 1: Retiree Portfolio Asset Allocation

Fund/Asset	Percentage
Money Market Funds	~34%
Intermediate Treasury Bond Fund	~14%
Ginnie Mae Bond Fund	~10%
Inflation Protected Securities Fund	~17%
S&P 500 Index Fund	~4%
Total Bond Market Index Fund	~9%
Gold ETF	~12%

Please note that I selected the allocations in table 1 to help me weather the financial crisis.  This is NOT a recommendation for your portfolio.  Remember that I do not know you, your risk preferences, your time horizon, or your investment objectives. Furthermore you should not change your portfolio based solely on something that you read on this blog (or any blog for that matter).  Please review the disclaimer at the end of the article for more information.

As I mentioned in Stay True to the Path or Take the Fork in the Road, cash is a legitimate position.  The only risks to cash is inflation and missed opportunities.  In order to hedge inflation risk, I chose to buy a gold ETF and inflation protected securities.  For general protection in 2008, I thought bond funds would do well as any return is better than the negative return I foresaw in stock markets.  The Total bond market index fund provided general protection across short, intermediate and long term bonds.  I added intermediate treasuries because they provided a better yield than short term, but less potential risk than long term and corporate bonds.  Ginnie Mae bonds are government-backed mortgage securities that also provided better yields.

While I have made few changes since 2008, I may make significant changes any time now as I have considerable exposure to the bond market. While interest rate risk is not yet keeping me up at night, it is something that I think about regularly. Interest rates can only go so low before they begin to rise again.  When that happens, bonds will lose money. I'm still formulating a course of action. So if this article causes you to think, "I'm putting more into bond funds" - please understand that I believe that they are no longer the safe allocation as they are traditionally perceived.

In 2007/2008, my goal was simply to make it through the crisis without taking a significant loss.  While I'm disappointed to have missed out on the stock market returns since March 2009, I take comfort in the fact that losses I had were minimal and that this portfolio grew better than 15% since October 2007.  Though nothing to brag about, I'll take the smooth low returns over the experience of large losses when the stock market dropped over 50%.

Dollar Cost Averaging Portfolio

While I no longer contribute to a 401k, my wife does.  Additionally, she recently started with a new company, so I was excited to see what investment options were available.  As what has been typical in my 401k experience, there was a dearth of index funds.  However, here are the funds that I chose for her along with the overall allocation.

 Table 2: Dollar Cost Averaging Portfolio Asset Allocation

Fund/Asset	Percentage
S&P 500 Index Fund	15%
TRP Blue Chip Growth Fund	10%
Fidelity Low Priced Stock Fund	15%
MSIF Small Cap Growth Fund	15%
DFA Emerging Markets Fund	15%
Harbor International Fund	10%
Nuveen Real Estate Fund	10%
PIMCO Total Return Fund	10%

Again, table 2 is NOT a recommendation for your portfolio.  Remember that I do not know you, your risk preferences, your time horizon, or your investment objectives. Furthermore you should not change your portfolio based solely on something that you read on this blog (or any blog for that matter).  Please review the disclaimer at the end of the article for more information.

Looking at the table above, you may be shocked to see 90% allocated to stock funds and only 10% to bonds.  Here is my rationale for these selections:

As my wife started recently, there have been minimal contributions to this account. Hence there is no significant account balance to be lost. As there is no significant balance, a large stock market loss means the next contribution very quickly averages the overall cost per share down. Thus I'm choosing funds that are considered more risky, like small company, mid-company, emerging markets, international stocks, and real estate. While this may seem counterintuitive to some people, I experienced the positive results when the stock market rose from the 2000 crash until 2007.

Additionally we have a long time horizon, so we can wait out any downturn.  Within this time horizon, small and medium companies should grow.  So I have allocated 30% of funds towards these categories. Likewise, I believe that international stocks will grow well as other nations want to be prosperous like the U.S.  Thus 25% of funds are allocated to international and emerging markets.  Also, bond rates will at some point rise.  While bond funds will lose money when that happens, dollar cost averaging enables me to again buy cheaper shares.

By now you've probably realized that I'm treating the dollar cost averaging portfolio on the complete opposite end of the spectrum as the retiree portfolio.  Again with regular contributions, my wife's portfolio is managing market pricing risk by buying cheaper shares in any downturn.  Even though we're in our mid-to-late 30s, this portfolio illustrates the advantage of a long time horizon, which is being able to weather more risk.

Parting Thoughts

I chose today's quote because much like sports, investing isn't about a single game - it's about the whole season. Championship teams can lose a few games during the season. However in order to win the season, you must have a defensive strategy to manage risks. Dollar cost averaging is one proven method to play defense in your retirement strategy.

In my Retiree Portfolio, I concentrated entirely on defense by selecting bond funds.  This worked - though not everyone wants or has the ability to actively monitor and manage risks.  This is why lazy investing shines, and one reason why I recommend lazy portfolios. Lazy portfolio's are another defensive strategy.  No doubt this is one of several reasons why many investment professionals use them.

For more information on lazy investing, check out:

• Lazy Portfolios on Marketwatch

Or look for the following books at your library:

• The Little Book of Common Sense Investing by John C. Bogle
• Millionaire Teacher by Andrew Hallam

Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

Keep It Short and Sweet

I hope everyone had a good weekend because it's back to the grindstone today.  I'll admit that I spent almost no time this weekend thinking about the markets or what was going on in the world.  It was wonderful to "get away."

However I did run across another piece I want to share.  I originally read this when Paul Farrell first published it on Marketwatch, but had totally forgotten about it until this weekend (hat tip: Big Picture Blog).  This one is from several years ago, and similar to lazy investing that I introduced in Maybe I'm Not a Lazy Investor, I do not ever see it going out of style.  From the creator of Dilbert, Scott Adams: The Unified Theory of Everything Financial.

Quietly hidden in Adams' groundbreaking work is a financial formula so simple it rivals Einstein's E=mc2. In its original form Adams' formula was apparently so heretical and so explosive that no major house would touch it when he proposed publishing it as a one-page book. After initial rejections, he announced sadly that "if God materialized on earth and wrote the secret of the universe on one page, he wouldn't be able to find a publisher" either. 

Fortunately for America's 95 million investors, Adams' secret nine-point formula was finally revealed in "Dilbert and the Way of the Weasels." Notice its simple brilliance in the exact reproduction of his formula:

1. Make a will
2. Pay off your credit cards
3. Get term life insurance if you have a family to support
4. Fund your 401k to the maximum
5. Fund your IRA to the maximum
6. Buy a house if you want to live in a house and can afford it
7. Put six months worth of expenses in a money-market account
8. Take whatever money is left over and invest 70% in a stock index fund and 30% in a bond fund through any discount broker and never touch it until retirement
9. If any of this confuses you, or you have something special going on (retirement, college planning, tax issues), hire a fee-based financial planner, not one who charges a percentage of your portfolio

Adams boldly states that this is "everything you need to know about personal investing." In just 129 words, nine simple points, one page you have the unabridged "Unified Theory of Everything Financial." That's it. Everything!

And I'm not going to muddy up the waters with any other comments, except to say - I agree, and I hope you have a good week!

Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

Worthwhile From the Web: Thoughts on Retirement with Dignity 2.0

The tiny, initial clue ... by allowing us to imagine what we do not know, stimulates a desire for knowledge.
- Marcel Proust

Knowing is not enough; we must apply. Willing is not enough; we must do.
- Johann Wolfgang von Goethe

Welcome to Worthwhile from the Web.  Ok, the name is corny, but I wanted you to be able to easily distinguish independent articles that deserve your time from my own articles (that also deserve your attention).

Tonight's article is from The Big Picture Blog and likely requires more than 1% of your time.  Written by a bond manager, it provides an in-depth look at what an 80th percentile, middle-age baby boomer likely faces regarding future retirement.  Entitled Thoughts on Retirement with Dignity 2.0, the author reviews these baby boomers backgrounds, prospects for retirement, options in achieving retirement, and implications on the economy.  Here's a preview:

The 80th percentile 57 year old household income is little changed from 2 years ago (or 4 years ago, for that matter) and stands at $150,000. They have, on average, a $200,000 mortgage on a home valued in the low $300 thousands. (The value was $370,000 in 2007). If they have a 401K or IRA, the balance is approximately $100,000. Other assets and liabilities are very difficult to generalize and quantify. The quantity and frequency of debt beyond a first mortgage is significant and so is non-retirement plan financial assets, but they appear to generally offset each other. It is safe to say that; if you Google Earthed the $315,000 neighborhood in Columbus, Ohio and pulled out the 57 year old household, you might find that their home equity loans, education loans and auto loans offset their financial assets excluding home and retirement accounts. If that were the case, they are $100,000 in the hole with eight years to go to retirement.
...
Since 1999, the S&P 500 Index is flat, but there have been two 50% decline phases and numerous leadership changes. In general, the public has been put through a meat grinder in the stock market for the last 12 years.
...
Based on a conventional approach, these 57 year olds need to accumulate about $3 million in retirement savings in the next 8 years in order keep everyone happy. That figure is based on the calculation that they need to replace $150,000 per year in employment income when they quit working and they will receive about $30,000 in Social Security, leaving a $120,000 funding gap. It takes $3 million to fill the gap at a 4% distribution rate.
...

I came up with 3 primary actions that can be taken in order for these 57 year olds to retire comfortably, if taken together. All of them will have a potentially negative impact on the economy.
1. Postpone retirement to age 70 or older
2. Cut the household budget and save the difference
3. Liquidate debt by downsizing
...
They need to take the $115,000 in spending down to, say, $75,000. Talk about choking the horse. But it certainly can be done. That will facilitate $40,000 in annual savings, but what is really cool is that, after adapting to the pain of austerity and establishing a less expensive lifestyle, the savings goal drops to $1,080,000! 

Whether you are baby boomer or just starting out, I strongly encourage you to read the complete article Thoughts on Retirement with Dignity 2.0.

Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

Light at the End of a Tunnel or a Coming Train

If you saw a potential train crash coming, would you stand on the tracks in the hopes that the train might stop in time, or get out of the way?  Many Europeans from Greece, Portugal, Spain, and Italy are choosing to get out of the way.  The potential train wreck they foresee is either their country abandoning the euro or a possible break-up of the euro-region.

Regardless, this leads to the possibility of returning to the drachma, escudo, peseta, and lira for these countries.  A return to any or all of these currencies would very likely lead to a large currency devaluation - meaning a $5 bottle of wine could very well cost $10.

Thus these Europeans are protecting their wealth by moving it to other countries they assume will keep a strong currency. By moving their wealth, these Europeans hope to retain its value by retrieving it after the devaluation occurs. From Der Spiegel: Southern European Money Migrating North to Safety

Nowhere, though, has capital flight reached the dimensions that it has in Greece. According to data released on Monday by the European Central Bank, deposits in Greek banks plunged by 17 percent last year. Other countries in crisis have also seen declines, but they have been much smaller. In Ireland, deposits fell by 6 percent, in Spain it was almost 3 percent, and in Italy it was just under 2 percent. By comparison, deposits in Germany in the same time period climbed by 3 percent and, in France, the increase was fully 10 percent.

Yet as deposits leave these countries, the situation leaves their banks with a shortfall in funding.  The graph above illustrates the relative amounts borrowed by European banks from the European Central Bank (ECB).  In July 2010, Portuguese banks required over 25% of Portugal's monthly economic output in loans to continue operating.  And from ~June 2011, the trend for Greece, Spain, and Italian banks has been to borrow more money.

This graph also illustrates why European banks need the ECB's Long Term Refinance Operation (LTRO).  These banks desperately need capital in order function.  Without the ECB loans, everyone would see that these banks are insolvent because they would need to shut down.  Take a look at the growth of loans leading up to the LTRO spike in December 2011 in the graph below.

The growth starts around June 2011 and then spikes in December with the LTRO.  As noted in To the Moon and Back:

What about the Long Term Refinancing Operation (LTRO) by the ECB - didn't it loan out nearly €500 billion in December? As revealed by Hussman Funds in Five Global Risks to Monitor in 2012, the €500 billion is more like €191 billion. (emphasis mine) 

While there was much fanfare last month after the ECB loaned 523 banks 489 billion euros, the actual amount of new funds was a more modest number. This is because two earlier loan programs expired on the same day as the three-year LTRO was held, and banks probably rolled these funds into the three-year operation. The earlier operations included a 3-month loan of 141 billion euros offered in September, and a net 112 billion euros of overnight loans. The ECB also allowed banks to shift 45 billion euros from an October operation into the 3-year LTRO. Of the 489 billion Euros operation, that left about 191 billion euros of fresh loans.

That spike looks about right for that amount.

Yesterday the ECB loaned more than €500 billion to 800 banks in the second installment of the LTRO - meaning Europeans continue to protect their wealth by moving it to safer destinations.  I agree as they would be insane to trust good intentions.  Why risk the light being a train?

The ECB is buying more time for leaders to try and find a solution.  The game of extend and pretend goes on.


Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

Tracking Your Path to a Financial Future

I was scamming those guys for months. Every transaction, I kept a little.

You?

It was easy. Cash deposits! 

Millions of dollars in small bills changing hands.

Who's going to miss $10,000 here, $20,000 there?

Drug dealers.

That's right.  They did. It's why I'm living out of a suitcase now.
- Lethal Weapon 2

Yes, it's that time of the month again - where we get to play "Where did my money go?"  In November 1999, this "game" was like running lines (a.k.a. suicide drill) in basketball practice where you run to the free throw line and back, half court and back, far free throw line and back, and full court and back.  Did I mention the loser gets to go twice?

Seriously I had no clue of where my money was going.  Even better, sometimes I got to play the game a week early.  When I tried to remember what I did that month, I always thought "it's not like I'm living extravagantly."  

For example, my one bedroom apartment cost less than $500 per month.  When I found it I thought "perfect", though I could tell by the look my hot realtor gave that she wouldn't be visiting if we ever dated.  I guess she didn't understand that I needed to save a few bucks if I ever wanted to take her out for something more than a hot dog.

Furthermore I didn't have new furniture or electronics or car.  The only debt I had was a student loan, and a credit card that I paid off monthly.  I was a frugal person.

Frugal as in - thrifty, economical, careful, cautious, prudent, unwasteful, sparing, scrimping; abstemious, abstinent, austere, self-denying, monkish, spartan; parsimonious, miserly, cheeseparing, penny-pinching.  Ok, I don't know about cheeseparing, which sounds like something done in Wisconsin, but I was frugal.

Where did my money go? Why was I unable to save anything? How could I possibly ever meet any financial goals?

If you haven't guessed already, tonight's discussion is tracking your expenses because if you don't know where your money is going, you shouldn't be surprised when you wake up thinking "I've been working for X number of years and what do I have to show for it?"

While it may seem like wasted time, tracking your expenses is beneficial because then you be able to: 

1. Set financial goals.
2. Monitor where you spend money.
3. Budget future expenses.
4. Cut unneeded and unnecessary expenses. 
5. Project Future Expenses.
6. Save.

*By the way if you already track your expenses, feel free to skip to the bolded section title In Other News.

Setting Financial Goals

Saving for an emergency fund, buying a new car, saving a downpayment for a house... Setting financial goals is easy because financial goals tend to be our dreams, our desired future.  Realizing that dream, let's just say there's a reason it's called work.

Monitoring Where You Spend Money

Monitoring where you spend your money is the first step in planning your financial future.  While it may seem mundane to write down your rent, utilities, and groceries on a monthly basis, the really tedious part is writing down your cash expenditures.  It takes discipline and is completely necessary if you want to know where you spend your money.

Regarding how you monitor your spending, you have many options:

• Paper - I remember watching my father write entries on paper while watching Sunday sports.
• Computer programs - several are available.  The reviews you can find online will be better than any I can provide.
• Spreadsheet - being frugal, I chose to make my own spreadsheet to track my finances.

Tracking Finances with a Spreadsheet

After only one month of tracking my spending cash, I was able to pinpoint why I was always asking "where did my money go?"  It was going to lunches, eating out on weekends, road trips to see my friends, beer, and cover charges.  And in case you're wondering, I had a section in my spreadsheet for cash expenditures that I tracked to the dollar as tracking to the penny wasn't worth it.

Budgeting Future Expenses

After tracking your expenditures for a few months, you will then be able to budget. To budget means that you devise a spending plan based upon your income and your financial goals.  Then you evaluate the plan based upon your expenditures and achieving your financial goals. 

If you budget successfully the first time, congratulations - you are either very good at matching income to expenses OR earn a lot of money.

If you were not successful, try again by cutting expenses, picking up an odd job, or getting a roommate to share the rent. And don't feel too bad because the government isn't very good at budgeting either and they've had a lot more time to practice.  Remember though that like government, you can take out debt to make ends meet. Unlike government, you cannot print your own money or raise your own debt limit to keep things going.  Avoid debt at all costs.

Cutting Unneeded and Unnecessary Expenses

Everyone who has written this topic takes a free shot at $4 lattes and work lunches.  However have you ever looked at how much a month you spend on ATM fees?  Taking your money out once can result in a fee up to several dollars.  Do it multiple times in a month and you may be able to treat a few friends to $4 lattes.  Through budgeting, you should be able to take money out once a month which limits ATM fees.

Budgeting also aids you in identifying other unneeded or unnecessary expenses.  When it comes to meeting your financial goals, gym memberships, weekly massages, designer clothes/shoes, cable TV, and even cars can be unnecessary.  By the way if you disagree because you need one of those items to do you job, then it is a necessary expense - not unnecessary one.

Projecting Future Expenses

I'm probably a nerd (my wife just said, "what do you mean probably? You developed your own spreadsheet.") because I love projecting how future financial scenarios impact my goals.  Tax return coming?  Now we meet our vacation budget.  Unexpected bonus?  Now we'll be able to pay off a student loan 6 months earlier.  And what can we do with that extra money once it is paid off?  Thank you budgeting.

Saving

Here's one tip that I read a long time ago: Pay yourself first.  When you get a check, set aside $25, $100, whatever amount in savings.  Pay yourself before paying rent, utilities, anything.  This is important because remember that you work to make your life better, not just to pay the bills.  By paying yourself first in your budget, you force yourself to review what is unneeded and unnecessary.  Thus, budgeting also enables you to save.  (Check out Time is Money or Time Earns Money to learn about the dynamics of saving and compound interest.)

Summary

Ultimately by tracking you finances, budgeting your expenses, and saving, you will achieve your financial goals.  Now get to it!

In Other News: Let's Revisit Our Discussion on Risk

Building on Market Risk, Are You Managing It, there was an article in Marketwatch yesterday about price earnings ratio of the S&P 500. From Stock valuations now versus last April:

The S&P 500 index, for example, is just 0.3% higher now than where it closed at the end of last April. For all intents and purposes, that’s a wash — especially considering the extraordinary volatility the market has had to endure along the way.
...
Consider first the price-to-earnings ratio when calculated on the basis of trailing as-reported earnings. The reason to calculate the ratio this way: It’s comparable to the historical values back to 1871 that are included in the database maintained by Yale University finance professor Robert Shiller. ( Click here to access that database. )

That ratio for the S&P currently stands at 15.2. The comparable ratio at the end of last April stood at 16.6. So at least according to this measure, stocks are about 8% cheaper today than last April.

What about the so-called Cyclically Adjusted Price Earnings ratio, or CAPE, which Shiller has proposed as a superior measure of stock market valuation? It currently stands at 22.7, versus 23.7 at the end of this past April — a 4% improvement.

Though the magnitude of these improvements are perhaps not overwhelming, at least their trends are in the right direction.

The Cyclically Adjusted Price Earnings ratio is the 10 year moving average discussed in Market Risk, Are You Managing It.  Back to the article:

Though Shiller’s Cyclically Adjusted Price Earnings Ratio is slightly lower than it was at the market high last April, it remains significantly above its long-term norms. In fact, it is 38% higher than the ratio’s average back to the late 1800s, and 43% higher than its median.

This cannot easily be dismissed because Shiller’s CAPE has an impressive record forecasting the market’s long-term return. Consider a simple econometric model that uses the CAPE to predict the S&P 500’s inflation-adjusted dividend-adjusted return — a model that is quite significant at the 95% confidence level that statisticians often use to determine if a pattern is genuine.

That model’s current forecast: Less than a 1% annualized real total return over the next decade.

Very interesting indeed... and with that, it's time to call it a night.

Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

Market Risk, Are You Managing It?

History doesn't repeat, but it often rhymes. 

- Mark Twain

Before we get into today's edition of 14 Minute Investor, I wanted to share why I've been missing in action these past few days.  In case you haven't read Maybe I'm Not a Lazy Investor, my full time occupation is stay-at-home dad.  Occupied is exactly what my 5 year old and 2 year old keep me.  Rather than delve in the details, please understand that I usually find myself writing after bedtime - more often than not, my own bedtime.  So while I strive to write one article for each day of the workweek, please forgive me if I miss a day.  I'd rather skip a day than try to rush an article out that isn't up to my standards.

Now on to the article...

Have you ever wondered what the difference is between good investors and great investors?  While I cannot say that I have a complete answer to this question, I know one difference is how each investor manages risk.

What Influences Your Investment Decisions

Very early in my investing lifetime, I looked at the past returns of my 401k mutual funds and said, "I want those returns."  As I started in the late 1990s, the returns were large by historical standards.  Indeed I got to enjoy about 2 years of nice returns.  However, the good times came to an end.  From Maybe I'm Not a Lazy Investor:

In March 2000, people decided that companies should earn a profit and not simply count how many eyeballs look at them daily. Over the next several months, the stock market crashed and so did my 401k. 

During this time, I did what I was supposed to do. I kept on buying, which dollar-cost averaged my nest egg into cheaper shares. Still, that didn't take the pain away. I decided that I needed to learn how to look for warning signs of future market crashes, as well as learn from my mistakes - such as not having diversified into a bond fund those initial years, which would have significantly cushioned the blow.

... 

Since the Nasdaq Crash of 2000, I had become a voracious reader of economic and financial subjects.

Source: Yahoo

Did you notice anything in particular about my opening sentence?  Here it is again: Very early in my investing lifetime, I looked at the past returns of my 401k mutual funds and said, "I want those returns."  One word stands out to me - returns.  I was managing for returns, and my portfolio suffered.  

What I should have been doing was managing risk. Managing risk is critical because if you do a poor job managing risk, then losses hinder the potential growth of a portfolio.  For example if you lose 50% of your portfolio, then you need a 100% gain simply to get back to even. 

By prudently managing risk, investment returns will follow as losses should prove minimal.  And while there are several types of investment risk that need to be managed, this article introduces one type - market risk.

Measuring Market Risk in 1999

Remembering those days 12 years ago is somewhat of a blur.  One thought I clearly remember is "from now on, I want to know what the 'smart money' is doing.  Certainly the smart money knows about managing risk."  I cannot recall how many websites and periodicals I reviewed attempting to find the "smart money" as it was a lot.  Being frugal, I decided to try a magazine subscription or two and then focused on finding the best material that was free over the Internet. One of the websites that I discovered was Minyanville.

Minyanville is the brainchild of CEO Todd Harrison who created it to give something back to the community after many successful years in the financial industry. Minyanville's mission is to affect positive change through financial understanding, from the ABCs to the 401(k)s. With a roster of more than 40 world-class "Professors" comprised of traders, money managers and some of the best minds in business, readers can find well over a dozen free daily articles as well as subscription products.

I spent a LOT of time and learned a lot of things on Minyanville.  Today, I'm going to share one of the most memorable things I saw there about 8 years ago.  As you might guess, it's centered on market risk.

Source: Tesseract Asset Management

Much like the concept of lazy investing, the chart above from Kevin Tuttle of Tesseract Asset Management (formerly Tuttle Asset Management) was an eye-opener to me, and let me tell you why.

In front of you is 103 years of the Dow Jones Industrial Average (DJIA) living history. Broken into two sections, this chart displays the price history of the DJIA over time on top, and the 10 year moving average Price/Earnings (P/E) ratio of the S&P 500 on the bottom.

Now for the uninitiated, P/E is a standard measure of risk. It tells you how many dollars you are paying for $1 of earnings performance.  From the articles I was reading back then, $15 was considered fairly valued.

Taking a look at the chart's P/E section, you'll note the two horizontal lines representing P/E ratios of 10 and 22.  At 10, stocks are considered undervalued and on sale.  At 22, stocks are considered overvalued and at risk of falling in price.

Take a look at the year 1999.  I wish I had seen this chart back then as the P/E portion of the chart was lengthened vertically just to fit the curve.  Stocks were not only overvalued, but in orbit with the International Space Station.

Taking a Closer Look at Cyclical Market Risk

I am grateful to have permission to use the 2010 chart, so let's take a closer look at all of the information we can gain from it (please click the image to enlarge it).

Source: Tesseract Asset Management

To this day, I have never seen a chart like this.  This chart is significant because it matches up market risk versus price performance in an easy-to-read graphic - not a table that listed over a range of years both the high/low price for a year, the high/low P/E for that year. Thus we can visualize the long-term, or secular, trends easily.

Focusing on the P/E portion again, we see that market risk is constantly changing.  Over many years though, these changes trend from low-to-high P/E (represented by rising blue line) to high-to-low P/E (represented by falling red line).  Note that the blue lines always start at or below an undervalued P/E of 10.  Likewise, the red lines always start at or above an overvalued P/E of 22.

Now let's look at the DJIA price history.  The first thing I notice are rising blue lines designating rising stock prices.  These rising stock prices directly correlate to the blue lines below designating a rising P/E and take place periods many years.

Next, the black "channels" designate years where the market remains within a price range, or as the chart says - experiences a secular consolidation.  These black channels, as well as the market crash from the Great Depression, directly correlate to the red lines designating a falling P/E.

Putting it all together, we see that over long periods of time, the stock market cycles from undervalued to overvalued and back. Note that secular bull markets can go up far longer than many would think prudent.  Additionally caution should be exhibited in overbought markets as they tend to work themselves out as either:

1. a function of price, meaning a large, "quick" drop in price like in the Great Depression - bringing the overall P/E ratio down to undervalued levels, or
2. a function of time, meaning a long multi-year, secular consolidation where corporate earnings catch up to price - bringing the overall P/E ratio down to undervalued levels.

Benefits of the 100 Year Market Theory Chart

As the quote of today's article says, history doesn't repeat, but it often rhymes.  Since 2000, the stock market has been consolidating as a function of time.  Reading the 100 Year Market Theory Chart, we see that the 2008 crash has yet to tag the traditional undervalued P/E of 10.  Thus, it can be surmised that the current secular consolidation that started in 2000 should continue.

Yet A Word of Caution

Even though the 100 Year Market Theory illustrates that stock market risk cycles from undervalued to overvalued, policy intervention from governments and central banks may prevent markets from hitting a P/E of 10. 

As mentioned in How Many Bulls in this Rodeo, Clowns Want to Know world central banks are flooding global markets with liquidity.

The G4 central banks (http://www.cumber.com/content/misc/G4_Charts.pdf) have taken the size of their collective balance sheet from $3.5 trillion to $9 trillion. That number is likely to rise. The G4 have extended duration so that the focus of their policy is not just in the overnight lending rate or in the very short term. Massive liquidity has blunted liquidity squeezes everywhere in the world.

And from  It's Only Good for a Limited Time:  

... by unleashing a flood of liquidity in the form of low interest rates, quantitative easing, and refinancing operations, world central banks distort financial markets encouraging investors to take on more risk. Stocks are a natural fit, especially with reports and prognostications of an improving economy. Furthermore, the Federal Reserve has strongly hinted at more quantitative easing in December and January.

Now put yourself in the shoes of a financial manager. Your worst fear is the thought of underperforming your peers. To a financial manager, underperformance is worse than losing money. Thus it is to be avoided at all costs.

Liquidity finds a home in stocks and commodities, pushing up prices.  Can policy intervention start a new secular bull market when P/E hasn't hit the traditionally undervalued mark?  That remains to be see.

Another risk that I know I've beaten to death is the debt.  Can liquidity beat debt?  Again that remains to be seen, but debt has to be paid, restructured, or defaulted upon.  Whether we like it or not, we certainly do live in interesting times.

Parting Thoughts

The 100 Year Market Theory Chart bestows different benefits to different people.  For those who dollar cost average in their retirement plans, the chart provides a powerful incentive to continue the course during the current secular consolidation.  Your risk is managed by constant buying regardless of direction.  When the next secular bull market starts, you will be very happy.  Dollar cost averaging enabled me to regain from my losses much quicker than had I given up in 2000.

For people like me with retiree plans, the chart provides guidance on when taking more risk with our precious funds is prudent.  No one wants to out live their retirement funds.

While there's much more that can be discussed about 100 Year Market Theory Chart, it's time to wrap up this article.  Be assured that I will revisit the chart in future articles as today was really an introduction.  As a side note, I look forward to the 2011 chart.  As the market basically had a flat year and corporate earnings improved, I predict that the P/E line should have ended 2011 lower.  How much lower - I can't wait to see.

Finally in the spirit of finding the best material that's free over the Internet, I did see that Tesseract Asset Management offers Free Research. While I have yet to receive my first email, I will say that I read Kevin's work whenever I see it on Minyanville.  So I look forward to my first installment.


Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.