Last August, I made a bet with a hedge fund guy. He was sure that the economy was going into the tank and that the US would plunge into a deep and prolonged recession that would start at the end of 2007 and last well into 2008. I countered that I didn’t think that the US would see two negative quarters by the end of the first quarter of 2008. On the beach at Ditch Plains, Montauk, the bet was wagered: the winner would be treated to a large Sicilian pie from Umberto’s of New Hyde Park. I have resisted calling until the final revisions to GDP are in, but I am starting to think about what toppings I want on my pizza.
The bet never contemplated all of the wild events that have occurred since then, but this week, both the New York Times and Wall Street Journal noted that while the economy is hurting, it has not yet met the non-official definition of a recession, that is, two consecutive quarters of negative GDP. GDP for Q4 2007 and Q1 2008 was lame at +0.6%, but at least it was positive. The Times’ David Leonhardt noted that “you can make an argument that the economy has survived its period of maximum danger.”
Of course surviving does not equate thriving, but it is a far better outcome than many thought possible just six weeks ago. I like to call this period “Post-Bear Stearns” because in the time since the near-collapse of the fifth largest US investment bank, financial markets and the economy retreated from the brink of disaster. Credit goes primarily to the Federal Reserve, which has been both creative and aggressive in staving off a more significant crisis. The collective sigh of relief continues to reverberate from Wall Street to Main Street. Maybe that’s why retail sales were better-than-expected when they were released this week.
That doesn’t mean that everything is honky-dory. The housing market is still lousy (official term), job losses may have eased, but it would be better if the economy created jobs instead of losing them and then there’s that oil problem. Adding to that list, Federal Reserve Chairman Ben Bernanke said that conditions in financial markets are “far from normal…pressures in short-term funding markets persist.”
Where does that leave us? Well, the economy is weak and may in fact worsen in the coming months. Consumers who have held up pretty well might buckle under higher energy costs this summer and another shoe could drop in the credit crisis. But thus far, we have come through this difficult period in pretty good shape. And of course, it looks like I will be winning that pizza because the bet was a time limited one.
Friday, May 16, 2008
Thursday, May 15, 2008
Wonder, Blunder, Thunder and Plunder
I recently heard a legendary consultant deliver a great talk about managing closely-held businesses. He identified what he termed, “the four stages of entrepreneurial endeavors: Wonder, Blunder, Thunder and Plunder!” I could not help but translate this to your financial life, but in order to do so, I need to review each step and then apply it to what I will call the four stages of personal financial management.
“Wonder” begins with nothing—you have no business, no clients, no money, but you are filled with optimism. Most folks in this stage run the business—and that is a loose term, considering that it is just a dream at this point—by the seat of the pants. In personal financial management, this is where we all begin, unless we are lucky enough to be born into a family with lots of money. You remember when you got that first job and started to figure out that the government takes an awfully large portion of your check (“Dad-I think there’s a mistake with my pay stub!”) and you could barely pay your rent, but it was all new and exciting.
“Blunder” is when things start moving at warp speed. The business finally has profits, but no cash. In other words, the little idea has become a business, but there is tremendous stress and the owner clings to a crisis mode of management. In your real life, this is the period where you can’t believe that you made so much money and have nothing to show for it at the end of the year. Sure, you pay your bills and even have a house, but it feels like you are living paycheck to paycheck and there is no plan in place to help you get to the next place.
“Thunder” is a more mature phase of the business. The boss has become loud, opinionated, obnoxious and over-confident. He has formalized the management structure, but mostly so he can lecture the staff about his numerous ideas. This is often met with nods of agreement to his face and extreme eye-rolling behind his back. But nobody wants to rock the boat-the company is finally profitable and everyone is glad to be making money. In personal finance, this is usually when people accumulate real money for the first time in their lives, often through their retirement accounts. They usually do not have a plan, but “the numbers speak for themselves.” As a result, the Thunder-guy/gal believes that he/she knows better and does not need anything more. I always hope to meet people during the Thunder phase—it is when wealth management can have the most significant impact on the client’s life and can actually create opportunities for those who get on board with the process before the next stage robs them of possibilities.
The final stage, “Plunder,” is the fork in the road: it can either be a period of renewal or decline. It is a time when change smacks the entrepreneur in the face, as all of the “wisdom” that he has relied upon is now obsolete. If the business is fortunate, this is the moment when the boss recognizes that he must make changes or the business will slowly drift away.
In personal finance, Plunder usually occurs when the stock market swoons or during life-changing times like job-loss, disability or even death. It can be the moment when a couple faces up to the fact that the non-strategy that has been at play can not possibly see them through retirement and in fact, may be the reason that dreams must be put on hold. While I can also help those who are in the early part of Plunder, when they wait too long, I find that most suggestions are met with “yeah, but…” and they are simply going to plunder opportunity due to stubbornness.
“Wonder” begins with nothing—you have no business, no clients, no money, but you are filled with optimism. Most folks in this stage run the business—and that is a loose term, considering that it is just a dream at this point—by the seat of the pants. In personal financial management, this is where we all begin, unless we are lucky enough to be born into a family with lots of money. You remember when you got that first job and started to figure out that the government takes an awfully large portion of your check (“Dad-I think there’s a mistake with my pay stub!”) and you could barely pay your rent, but it was all new and exciting.
“Blunder” is when things start moving at warp speed. The business finally has profits, but no cash. In other words, the little idea has become a business, but there is tremendous stress and the owner clings to a crisis mode of management. In your real life, this is the period where you can’t believe that you made so much money and have nothing to show for it at the end of the year. Sure, you pay your bills and even have a house, but it feels like you are living paycheck to paycheck and there is no plan in place to help you get to the next place.
“Thunder” is a more mature phase of the business. The boss has become loud, opinionated, obnoxious and over-confident. He has formalized the management structure, but mostly so he can lecture the staff about his numerous ideas. This is often met with nods of agreement to his face and extreme eye-rolling behind his back. But nobody wants to rock the boat-the company is finally profitable and everyone is glad to be making money. In personal finance, this is usually when people accumulate real money for the first time in their lives, often through their retirement accounts. They usually do not have a plan, but “the numbers speak for themselves.” As a result, the Thunder-guy/gal believes that he/she knows better and does not need anything more. I always hope to meet people during the Thunder phase—it is when wealth management can have the most significant impact on the client’s life and can actually create opportunities for those who get on board with the process before the next stage robs them of possibilities.
The final stage, “Plunder,” is the fork in the road: it can either be a period of renewal or decline. It is a time when change smacks the entrepreneur in the face, as all of the “wisdom” that he has relied upon is now obsolete. If the business is fortunate, this is the moment when the boss recognizes that he must make changes or the business will slowly drift away.
In personal finance, Plunder usually occurs when the stock market swoons or during life-changing times like job-loss, disability or even death. It can be the moment when a couple faces up to the fact that the non-strategy that has been at play can not possibly see them through retirement and in fact, may be the reason that dreams must be put on hold. While I can also help those who are in the early part of Plunder, when they wait too long, I find that most suggestions are met with “yeah, but…” and they are simply going to plunder opportunity due to stubbornness.
Wednesday, May 14, 2008
The Professor Speaks
Have you ever looked at one of those graphs that looks like you can’t lose if you buy stocks? Of course you know that you can lose at any given year during the period highlighted, but these graphic illustrations are supposed to help you understand that if you have the intestinal fortitude to hold the volatile asset class of stocks during the ups and downs, you too can climb the mountain and end up with a bunch of money.
Want proof? If you had a great-great grandparent who purchased a dollar worth of US stocks in January, 1802 and you had inherited the position and held it until the end of 2007, you would have $766,854, or an inflation-adjusted annualized return of 6.8%. As a means of comparison, a dollar invested in bonds would get you $1,320, or a 3.5% annualized return. Parenthetically, if your relative bought a dollar piece of gold in 1802, it’s only worth $2.45 today (including the recent run-up) and the US dollar is actually worth -$0.06, or less than a dollar!
I was reminded of all of these numbers after attending a lecture delivered by legendary professor/writer/commentator Jeremy J. Siegel of the Wharton School of the University of Pennsylvania. Professor Siegel wrote the famous investment book Stocks for the Long Run (now in its fourth edition) for ordinary investors, so I wondered how the group of know-it-all investment advisors would respond to him. I am here to report that the Professor can captivate a room of even the most jaded insiders.
It was like attending a master class with Maria Callas. Professor Siegel started with the basics and built from there. Some key points that got the room nodding in unison included a reminder that the current yield of US Treasury bonds is 3.74%, but this is a nominal yield---it is necessary to calculate the real yield, which subtracts the inflation rate, which even at an assumption of 2.5%, would only get you 1.24%, not including the tax liability that you have by owning this asset class. This does not mean that you should never own bonds, but if you do purchase bonds, you should understand how they compare to stocks over a period of time. Professor Siegel noted that from 1926-2007, stocks yielded a real annualized return of 6.7%, and if we assume a similar future performance, then bonds look like a pretty rotten investment next to stocks.
Does this mean that you should only own stocks? Perhaps if you subscribe to this theory, you would trot out the mother of all bull markets--1981-1999, a time period when the annualized return of 13.6% (bonds did pretty well too, earning 8.4%). The bears would encourage the optimists to look at 1966-1981, when the annualized real return of stocks was actually -0.4%--ouch! These two periods are bookmarks, which is why Professor Siegel always comes back to his assumption of 6.7% as a long-term return, which happens to be the annualized return from 1926-2007.
But here is the thing about the Professor—his statistics are absolute, but as I have said many times, investors are human beings and very few have the ability to stay invested in a portfolio comprised of 100% stocks. The Professor’s research may show that a diversified portfolio actually eats into potential returns, but I look at statistics from the real world---it may be that a diversified portfolio will save an investor from himself and prevent an emotional response to market moves. For more of this kind of data, you should read Stocks for the Long Run and Professor Siegel’s newest book, The Future for Investors: Why the Tried and the True triumphs over the Bold and the New.
Want proof? If you had a great-great grandparent who purchased a dollar worth of US stocks in January, 1802 and you had inherited the position and held it until the end of 2007, you would have $766,854, or an inflation-adjusted annualized return of 6.8%. As a means of comparison, a dollar invested in bonds would get you $1,320, or a 3.5% annualized return. Parenthetically, if your relative bought a dollar piece of gold in 1802, it’s only worth $2.45 today (including the recent run-up) and the US dollar is actually worth -$0.06, or less than a dollar!
I was reminded of all of these numbers after attending a lecture delivered by legendary professor/writer/commentator Jeremy J. Siegel of the Wharton School of the University of Pennsylvania. Professor Siegel wrote the famous investment book Stocks for the Long Run (now in its fourth edition) for ordinary investors, so I wondered how the group of know-it-all investment advisors would respond to him. I am here to report that the Professor can captivate a room of even the most jaded insiders.
It was like attending a master class with Maria Callas. Professor Siegel started with the basics and built from there. Some key points that got the room nodding in unison included a reminder that the current yield of US Treasury bonds is 3.74%, but this is a nominal yield---it is necessary to calculate the real yield, which subtracts the inflation rate, which even at an assumption of 2.5%, would only get you 1.24%, not including the tax liability that you have by owning this asset class. This does not mean that you should never own bonds, but if you do purchase bonds, you should understand how they compare to stocks over a period of time. Professor Siegel noted that from 1926-2007, stocks yielded a real annualized return of 6.7%, and if we assume a similar future performance, then bonds look like a pretty rotten investment next to stocks.
Does this mean that you should only own stocks? Perhaps if you subscribe to this theory, you would trot out the mother of all bull markets--1981-1999, a time period when the annualized return of 13.6% (bonds did pretty well too, earning 8.4%). The bears would encourage the optimists to look at 1966-1981, when the annualized real return of stocks was actually -0.4%--ouch! These two periods are bookmarks, which is why Professor Siegel always comes back to his assumption of 6.7% as a long-term return, which happens to be the annualized return from 1926-2007.
But here is the thing about the Professor—his statistics are absolute, but as I have said many times, investors are human beings and very few have the ability to stay invested in a portfolio comprised of 100% stocks. The Professor’s research may show that a diversified portfolio actually eats into potential returns, but I look at statistics from the real world---it may be that a diversified portfolio will save an investor from himself and prevent an emotional response to market moves. For more of this kind of data, you should read Stocks for the Long Run and Professor Siegel’s newest book, The Future for Investors: Why the Tried and the True triumphs over the Bold and the New.
Tuesday, May 13, 2008
Kaizen in your Portfolio
I was reading an article in the New Yorker about Toyota (The Open Secret of Success, May 12, 2007 by James Surowiecki), which is considered to be the most profitable and innovative auto maker in the world. Don’t worry--this is not one of those articles about how we should emulate the Japanese approach to business – a very eighties notion. But the interesting nugget that I took away from reading about Toyota’s success is defined in a single Japanese word, kaizen, or continuous improvement.
Of course from a personal vantage point, we all want to improve who we are as spouses, parents, children and professionals, but that’s far too lofty a goal for today. I thought it would be great to apply the concept of kaizen to your financial life. According to Surowiecki, Toyota views innovation “as an incremental process, in which the goal is not to make huge, sudden leaps but, rather, to make things better on a daily basis.”
Let’s start with overall ways that you may be able to improve your financial life: the big three, which I consider: (1) Pay down your consumer debt (2) Establish an emergency reserve fund (3) Maximize your retirement plan contributions. Assuming you mastered these three “starter steps,” I would add another three: establish a retirement plan, implement your portfolio to reach your delineated goals and monitor your progress.
I know that these are often considered the “boring” step-sisters to the sexier and more exciting process of selecting investments. But remember that we are going for incremental improvement. This reminds me of how Rudy Giuliani’s top cop, William J. Bratton, approached the daunting task of reducing crime. He started with small steps to increase safety for the residents of New York City—get rid of the small annoyances and have more cops patrol dangerous neighborhoods. Little by little, dealing with minor infractions actually seeped into the mind set of everyone and almost magically, crime rates in NY City plummeted.
You can apply this process in the management of your investment process. Small steps like reviewing and rebalancing your overall asset allocation on a quarterly basis, could help you gain the discipline to sell high or buy low. Replacing higher cost investments with lower cost ones may allow you to add money to your bottom line each year. And finally, if you just don’t have the emotional strength or intellectual curiosity to manage your own money, make sure that you work with a registered investment advisor who you trust and who has the expertise necessary to help you reach your goals and objectives.
Of course from a personal vantage point, we all want to improve who we are as spouses, parents, children and professionals, but that’s far too lofty a goal for today. I thought it would be great to apply the concept of kaizen to your financial life. According to Surowiecki, Toyota views innovation “as an incremental process, in which the goal is not to make huge, sudden leaps but, rather, to make things better on a daily basis.”
Let’s start with overall ways that you may be able to improve your financial life: the big three, which I consider: (1) Pay down your consumer debt (2) Establish an emergency reserve fund (3) Maximize your retirement plan contributions. Assuming you mastered these three “starter steps,” I would add another three: establish a retirement plan, implement your portfolio to reach your delineated goals and monitor your progress.
I know that these are often considered the “boring” step-sisters to the sexier and more exciting process of selecting investments. But remember that we are going for incremental improvement. This reminds me of how Rudy Giuliani’s top cop, William J. Bratton, approached the daunting task of reducing crime. He started with small steps to increase safety for the residents of New York City—get rid of the small annoyances and have more cops patrol dangerous neighborhoods. Little by little, dealing with minor infractions actually seeped into the mind set of everyone and almost magically, crime rates in NY City plummeted.
You can apply this process in the management of your investment process. Small steps like reviewing and rebalancing your overall asset allocation on a quarterly basis, could help you gain the discipline to sell high or buy low. Replacing higher cost investments with lower cost ones may allow you to add money to your bottom line each year. And finally, if you just don’t have the emotional strength or intellectual curiosity to manage your own money, make sure that you work with a registered investment advisor who you trust and who has the expertise necessary to help you reach your goals and objectives.
Monday, May 12, 2008
Is the Worst Over?
I find myself thinking “the worst is over.” To keep that feeling in check and hopefully prevent myself from getting snared in a bear market rally, I thought that it would be useful to ask the question: what if we’re not in the 8th or 9th inning---what if we are just in the dreaded 5th inning?
One of the main thorns in the side of the rosy outlook is housing. Considering that all of the problems that we are currently encountering stem from housing, the fact that it is still in the tank is problematic. We need to see home sales and prices stop falling and for buyers to come in and sop up the excess inventory. Until home prices find a bottom, delinquencies will continue to rise, keeping credit markets unsettled and relatively tight, and consumer confidence and spending anemic.
In addition to the housing/credit crunch, there is also the issue of soaring energy and food prices. Crude oil closed at $124 on Friday, up from $88 in early February and from $50 in January, 2007. The powerful move has come without a significant correction or even an extended sideways move. I had expected that the US/G-7 economic slowdown would dampen energy prices and in those areas, demand has certainly abated. However, in certain parts of the world (China, Russia and the Middle East), domestic oil is subsidized – obviously there is no incentive to reduce demand when you are not paying the full price to fill your tank.
The World Bank reported that over the past three years, food prices have increased by 80%. What is important to note is that farmers are producing record harvests, so the problem is not supply, it is an increase in demand, which has sent prices of rice, wheat and corn skyrocketing. The good news is that the global food crisis likely peaked in April-March and since then, agricultural commodities have pulled back.
As I continue to weigh the inning count, I think that the best news is that time that has elapsed from the March 17th lows without additional negative surprises. The “post-Bear Stearns” period has been healing in nature, allowing the US economy and financial system to absorb and recover from the myriad of body blows it has taken. Given all that has occurred, I am often struck that markets (and investors, for that matter) have been as resilient as they have been. The bears will note that there could be more problems ahead, but I come back to the fact that real negative rates exist; aggressive Fed policy/monetary easing should persist; and we are awash in liquidity. All of these factors should be bullish for the stock market and the economy over the long term.
One of the main thorns in the side of the rosy outlook is housing. Considering that all of the problems that we are currently encountering stem from housing, the fact that it is still in the tank is problematic. We need to see home sales and prices stop falling and for buyers to come in and sop up the excess inventory. Until home prices find a bottom, delinquencies will continue to rise, keeping credit markets unsettled and relatively tight, and consumer confidence and spending anemic.
In addition to the housing/credit crunch, there is also the issue of soaring energy and food prices. Crude oil closed at $124 on Friday, up from $88 in early February and from $50 in January, 2007. The powerful move has come without a significant correction or even an extended sideways move. I had expected that the US/G-7 economic slowdown would dampen energy prices and in those areas, demand has certainly abated. However, in certain parts of the world (China, Russia and the Middle East), domestic oil is subsidized – obviously there is no incentive to reduce demand when you are not paying the full price to fill your tank.
The World Bank reported that over the past three years, food prices have increased by 80%. What is important to note is that farmers are producing record harvests, so the problem is not supply, it is an increase in demand, which has sent prices of rice, wheat and corn skyrocketing. The good news is that the global food crisis likely peaked in April-March and since then, agricultural commodities have pulled back.
As I continue to weigh the inning count, I think that the best news is that time that has elapsed from the March 17th lows without additional negative surprises. The “post-Bear Stearns” period has been healing in nature, allowing the US economy and financial system to absorb and recover from the myriad of body blows it has taken. Given all that has occurred, I am often struck that markets (and investors, for that matter) have been as resilient as they have been. The bears will note that there could be more problems ahead, but I come back to the fact that real negative rates exist; aggressive Fed policy/monetary easing should persist; and we are awash in liquidity. All of these factors should be bullish for the stock market and the economy over the long term.
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