November 15th, 2008 by Ted Toal
The other day I was waiting in line to order lunch when I overheard a young broker talking more loudly than I consider polite on his cell phone. He looked frazzled and blurted out that he had finally capitulated. He had called all his clients and told them he was selling their investments and going to cash to wait out the bad market. My first inclination was to feel sorry for his clients. I understand how they feel and commiserate with them as this difficult market has shrunk all of our account balances around the globe - and yet, the broker was about to compound their problems. I then shook my head in contempt for their broker’s gross error. He was engaging in the most well documented investor mistake in the history of recorded investment behavior.
He succumbed to emotion, sold securities whose prices had fallen, and is consciously waiting for them to rise until he buys them back. Selling and going to cash means you are waiting to feel better until you reinvest your assets. When will you feel better? You’ll feel better after security prices have already gone back up. By moving to cash in a down-market, you would be making a conscious decision to sell low and buy high. Yes, I recognize that it sounds like blatantly unintelligent behavior - but that is precisely why the overwhelming majority of investors fail to earn market rates of return. They flee to cash, CDs, or bonds when stock prices are low and repurchase stocks to join the recovery well after it has begun.
The evening news will tell you about some worried investors who are “losing” all their money in the stock market. Of course, investors who are properly diversified across the global equity will be able to take part in the market recovery in its entirety.
I say this because some investors will inevitably not be able take part in the eventual market recovery. That group includes investors sitting around in cash, and those who held concentrated positions of Fannie Mae, Freddie Mac, Bear Stearns, Lehman Brothers, or similar companies. Those single stock investors took on uncompensated risk and paid dearly for it. Uncompensated risk refers to the premise that you do not earn more risk-adjusted return by investing in individual stocks than by investing in the market at large. Single stocks do subject you to the risk of permanent and total loss.
Prudent investors, on the other hand, only take on compensated risk, seeking to earn the long-term returns to which they are entitled to for the amount market risk that we bear. They hold baskets of more than ten thousand securities and diversify away any uncompensated (single stock) risk.
The fastest way someone can make a bad market worse for themselves is to panic and suddenly act as if they didn’t know that markets periodically go down. Continue to have confidence. Prudent investors (and, those who are receiving proper professional advice) know the truth, which is that markets fluctuate and that recovery is certain. You cannot build financial security via a well-researched, disciplined investment plan when you abandon it as soon as it comes under stress. Recoveries are not easily foreseen events. You, me, pundits, economists, or other so-called experts do not know the timing of recoveries. To accomplish your goals and to earn those long-term market returns you need to fully participate in all market recoveries - and that means no emotional flight to cash allowed.
Tags: investor emotions, investor psychology, Markets
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November 4th, 2008 by Ted Toal
Thank goodness, October is over.
Market historians were busy last month rewriting the record books on what seemed like a daily basis. Unfortunately, many of the new records were the type that we’d prefer to have remained unbroken. Here are a few of the new entries:
- October was the most volatile month in the S&P 500 index since November 1929, as measured by moves of at least 1% higher or lower, according to MarketWatch.
- As of October 28, this bear market represented the fourth largest decline in the S&P 500 index (on a closing basis) without a 20% rally. The only three other periods where we had deeper declines without an intervening 20% rally were in 1931, 1938, and 1974, according to Bespoke Investment Group.
- On a positive note, the Dow Jones Industrial Average rose 946 points, or 11.3%, last week. Barron’s said it was the Dow’s biggest one-week point gain on record and its largest percentage rise in 34 years. However, the end of the month heroics couldn’t overcome the early in the month carnage as the Dow still lost 14.1% for the month.
- Crude oil prices dropped more than 32% in October, the largest one-month drop on record. That’s good news for those of us who drive because the fall in oil prices has led to a dramatic drop in gas prices.
- The Conference Board Consumer Confidence Index™, fell to an all-time low of 38 (1985 = 100) in October, according to data from the Conference Board as reported by MarketWatch. This does not bode well for upcoming holiday sales.
- Gold futures prices dropped 18% in October, which was the largest one-month decline since February 1983, according to data from the Comex division of the New York Mercantile Exchange.
They say records are meant to be broken. Well, we broke our fair share in October. Let’s hope the next broken record is a positive one such as, “The fastest return to an all-time high after experiencing a 40% decline in the S&P 500 index.”
All in favor, say “Aye.”
Tags: market update, Markets
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October 28th, 2008 by Ted Toal
If you find yourself feeling pessimistic about the short-term outlook for America, consider the words of Alexis de Tocqueville. During the 1800s, the author of Democracy in America said: “Born often under another sky…the American…grows accustomed only to change, and ends by regarding it as the natural state of man. He feels the need of it, more he loves it; for the instability; instead of meaning disaster to him, seems to give birth only to miracles all about him.”
Imagine the consternation and worry felt by the Puritans when they landed in Plymouth, Massachusetts, at the end of December, 1620. They needed to build shelter and find food—in mid-winter—just to survive. In that context, the challenges we face today seem less daunting. Changing circumstances can bring difficult challenges; embracing these challenges can produce surprising, and often rewarding, results. For example, during the first six months of 2008, Americans faced the challenge of higher fuel prices. And, we responded by:
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Choosing alternative modes of transportation. The high price of gasoline has inspired many Americans to think twice before hopping into our cars. Instead of driving, we’re walking, biking, carpooling, and taking advantage of mass transit options. According to the Energy Information Administration, our choices have helped reduce gas consumption in the United States.
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Changing our thinking about cars—dramatically. We are trading in our big cars for smaller, more fuel-efficient options at an unprecedented rate, according to Edmunds AutoObserver. During April and May, trade-ins of small SUVs were up 37% and trade-ins of midsized SUVs were up 45%. What are people buying? You guessed it: the Toyota Prius.
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Moving closer to work or mass transit. There is an upsurge of interest in urban properties, which are holding their values better than suburban properties, according to a Coldwell Banker online poll. In particular, younger buyers and empty nesters are moving into urban centers to help lower fuel costs, reduce commute time, improve access to public transportation, and save on energy costs.
Our belt-tightening measures reduced our country’s oil consumption by about 800,000 barrels in just the first six months of 2008. (Last year, U.S. demand for oil grew at a pace of about 119,000 barrels each day.) In fact, the International Energy Agency cut its estimate for global oil demand in 2008 and 2009, because consumers in the United States are changing their lifestyles. Lower demand has helped drive down the price of oil. Oil was at $147 per barrel in July. By September, it was in the $90 per barrel range. What is the miraculous outcome of this change? Heating our homes this winter may be more affordable.
Americans are resilient.
Posted in Triton Wealth Management | No Comments »
October 17th, 2008 by Ted Toal
National Association of Personal Financial Advisors (NAPFA)
issues challenge to Congress and regulators to address consumer protection
ARLINGTON HEIGHTS, IL (October 14, 2008) - The National Association of Personal Financial Advisors (NAPFA), the country’s leading professional organization of Fee-Only financial advisors, released the following statement today as a result of continued financial chaos:
Americans are seeing the results of gaps in financial services regulations. Even more important, Main Street has been adversely affected by the greed of the leaders of Wall Street firms, as they ignored their fundamental obligations to their own companies and the soundness of our financial system. Greater and greater risks were assumed and ignored, in pursuit of greater and greater profits.
In the weeks and months ahead, Congress and the state regulatory agencies will be re-examining the regulation of the financial services industry. We believe that individual investors deserve trusted personal financial advisors to assist them through the ups and downs of the capital markets. Only by embracing a mandated fiduciary standard of conduct for all financial planners will the American consumer receive truly objective, trusted advice which is in their best interests at all times. Our fellow citizens deserve nothing less.
NAPFA is calling on all consumers to have their voices heard by members of Congress as reforms are needed to ensure they are protected. To help, NAPFA has developed a form letter consumers can download at www.napfa.org. A link is also provided to help people identify their representative.
Tags: financial planner, investor protection, NAPFA
Posted in Triton Wealth Management | No Comments »
October 9th, 2008 by Ted Toal
With sincere empathy I can say that I understand how you have been feeling over the past few months as the bear market has deepened and stock prices have moved lower with increased volatility. I’ve said before that it’s okay to feel uneasy, dispirited, or even fearful as markets move through their occasional and expected down cycles. If you didn’t feel this way—you wouldn’t be human.
I spent much of September 30th, the day after the Dow dropped nearly 800 points, in the Philadelphia International Airport en route to a conference on structured investing. I was waiting in the gate for my aircraft to arrive and I began to realize that I was in the midst of the worst financial gloom and doom bombardment that I had witnessed to date. I was bracketed on two sides by gigantic plasma televisions tuned to CNN. The very suave CNN anchor’s austere voice was inescapably blaring over the loudspeakers in the terminal area. I stopped dead in my tracks when I read the bold headline on the screen: R.I.P. American Dream.
The CNN anchor then stated with deadpan stoicism that “What’s really at stake here is the American Dream. Law makers are now uncertain that their children will be able to live the American Dream.” Honestly, I instantly started laughing—and I hadn’t even had my morning coffee yet. In retrospect it must have seemed inappropriate to the concerned CNN viewers at the gate, but it was my natural response. R.I.P American Dream? Are you kidding me? That is so preposterous that it almost escapes explanation.
In the airport, my bemusement shortly turned to anger when I realized that I wasn’t watching some second rate charlatan on CNBC, but I was watching the revered CNN. This was a network that some rely on for real news, not so much the infotainment we find elsewhere. I knew that no one would hold networks accountable for furthering unnecessary hysteria. Then I started to examine my surroundings a bit more closely and I saw the cover pages of the New York Times, USA Today, and the Philadelphia Inquirer and I noticed that they all contained somewhat less egregious, but equally unsettling versions of CNN’s senseless proclamations. I couldn’t help, but feel sorry for the others in the airport, and all targets of this bombardment.
I want you to have the confidence and perspective to have the same skeptical reaction when you see something ridiculous like that segment on CNN. Please understand that sensationalism and trumped-up threats of the year 1929 help ratings, not investors.
The media barrage was in full swing and despite my wandering through the terminal I couldn’t escape it. A different network segment was introduced: Crisis Watch —Is your money safe? I thought, “Wow, this network is really doing some damage to the psyche of the investor at large.” The shot then turned to a screen divided into seven shots to accommodate the seven “experts” just waiting for the market to open so they could offer their obligatory incoherent conjecture as to why it made its every oscillation. It was at that point that I heard one of them use the word “unprecedented”—which, of course, intimates that this time is different.
I’ve heard the term “unprecedented” kicked around a lot lately and I have to assert that its use is wholly inappropriate. This bear market is roughly 13 months old and has seen a decline in the broad U.S. market of roughly 34% as I write this article. We have experienced much longer and much deeper bear markets even within the past decade…you may recall the post tech-boom bear market lasting 927 days with a peak to trough drop of 49% in the US equity market. In the past two decades we’ve seen the Russian government default on its debt, the Japanese economy suffer an Icarus-like fall, the 22% one day drop of October 1987, and numerous other precedents for stock price movements like this one.
The result has always been the same. No matter how apparently desperate the crisis—the market is resilient and recovers. The investors who are similarly resilient enjoy that eventual recovery and ill-advised or panicky investors miss out and get back into the market much later, just in time to catch the full brunt of the next bear market.
Tags: bear market, investor emotions, investor psychology
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October 6th, 2008 by Ted Toal
“We cannot assume that even if the economic news gets worse that prices will decline further. It’s quite possible that prices are already reflecting investor concerns of more trouble ahead and may rise despite more gloomy business reports in days and months to come.” - Weston J. Wellington.
Dimensional Vice President Weston Wellington offers perspective on the unpredictability of market movements, how the current market downturn compares to past bear markets, and the resilience markets have historically shown.
Is It Different This Time?
Tags: bear market, investor emotions, Weston Wellington
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October 6th, 2008 by Ted Toal
There’s only one word to describe what took place in the financial markets last week – ugly.
You probably don’t need to glance at the box score below to know that stocks dropped significantly last week. Monday’s dizzying drop of 777 points in the Dow Jones Industrial Average, attributed to the House of Representative’s failure to pass the bailout bill, set the tone. That was the largest point drop in Dow history, but in percentage terms, the 7.0% drop was not even in the top 15, according to MarketWatch. Interestingly, since the Dow was created in 1896, it has averaged a 7% or greater decline every 7 years. Coincidentally, the last time the Dow dropped more than 7% was on September 17, 2001 – just a fraction more than 7 years ago. While that offers little comfort, it does indicate that Monday’s decline was well within historical norms.
Monday’s decline was very broad based. Out of the 500 stocks in the S&P 500 index, 499 of them declined that day, according to Bespoke Investment Group. Can you guess the name of the only stock to rise that day? Here are a couple hints. First, when we’re feeling sick, our moms typically encourage us to eat the kind of food this company processes. And, second, for art lovers, Andy Warhol turned this company’s main product into pop art. You may have guessed that the company was none other than Campbell’s Soup. How ironic.
By the end of last week, lawmakers had approved a revised version of the bailout bill that included enough sweeteners to garner a few more “yes” votes. What started as a three-page treatment from Treasury Secretary Hank Paulson turned into a 451-page behemoth by the time President Bush signed the bill last Friday. Unfortunately, the added girth only weighed it down and investors sent the Dow to a 157-point loss on the day it was signed.
Where do we go from here? Perhaps the best way to summarize our thoughts is to quote Admiral Jim Stockdale, the highest ranking U.S. prisoner during the height of the Vietnam War. In describing how he survived eight years of torture and imprisonment, he said, “You must never confuse faith that you will prevail in the end – which you can never afford to lose – with the discipline to confront the most brutal facts of your current reality, whatever they might be.” Simply put, having faith in the future and realism about your present situation is a good way to live and to manage money.
Tags: bear market, market update
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September 29th, 2008 by Ted Toal
The current global financial mess is a good reminder that it may pay to follow a few basic principles of good living. As a society, we’re inundated with messages that encourage us to spend, spend, spend, and buy stuff that might make us feel good in the short term, but in the long term could leave us with a migraine. For some people, the lure of easy credit and living the high life was hard to resist and they ended up getting in over their heads. By forgetting basic personal finance and life principles, some of these folks are unfortunately paying a heavy price.
As we survey the landscape, there are plenty of people and organizations who can share the blame for the situation our country finds itself in. Greedy financial institutions, hedge funds, investment banks, mortgage brokers, politicians protecting their jobs, ratings agencies, and regulators are just a few in a long list of culprits. But, at the end of the day, laying blame on other people won’t solve the problem or prevent the next one. Ultimately, we each have to be responsible for our own actions and do the best we can to make prudent decisions that protect our hard-earned assets. Here are a few basic principles that can benefit all of us:
- Live below your means. Consider saving at least 10% of your annual income. Before long, you’ll have a nice cushion that will help soften the blow if the unexpected happens.
- Buy adequate insurance. There’s no need to expose yourself to a major loss if you can insure the potential loss for a relatively small amount.
- Invest regularly. No one can predict whether the market will go up or down tomorrow, let alone next year. By investing regularly, you establish a discipline that may help smooth out some of the fluctuations.
- Don’t stress out over things you can’t control. We can’t control if there will be a thunderstorm tomorrow any more than we can control whether or not the $700 billion bailout package will be successful. What we can do though, is be proactive in preparing ourselves for whatever outcome may occur.
- Focus on what’s most important in life. We’re all given a certain amount of time on this earth and it’s in our best interest to use that time wisely. Spending time with your family, your friends, and helping others may help you stay sane in a sometimes crazy world.
Tags: Financial Planning
Posted in Financial Planning | No Comments »
September 23rd, 2008 by Ted Toal
In light of the recent turmoil, we thought it would make sense to discuss the past, present, and future of the current financial situation. This may help put things in context for you.
The Past:
In order to understand how we can get out of this mess, it’s necessary to figure out how we got into it.
The late 1990s is a good place to start. No doubt you remember those “good ol’ days.” The internet was changing the world, technology stocks were soaring, and the economy was humming along. It was a great time to be in the stock market as the S&P 500 index rose 220% for the five years ending December 31, 1999, according to data from Yahoo! Finance. That’s an average annualized return of 26% excluding reinvested dividends, which is simply phenomenal.
Of course, the good times didn’t last. The bubble popped and the S&P 500 declined by 49% between March 2000 and October 2002, according to data from Bespoke Investment Group. In order to limit the collateral damage to the economy from this steep decline, the Federal Reserve, under former chairman Alan Greenspan, embarked on a major interest rate cutting campaign to try and stimulate the economy. The Fed took the federal funds rate from 6.5% in May 2000 all the way down to 1% by June 2003, according to data from the Federal Reserve Bank of New York.
This precipitous decline in interest rates set the stage for the next bubble – real estate.
With interest rates super low and the stock market in a funk, investors turned their attention to the previously moribund real estate market. As the economy gradually improved, people started to buy homes again in a big way. And banks, mortgage companies, and Wall Street wizards were more than happy to come up with new fangled ways of getting Americans into the home of their dreams with little to no money down.
Wall Street investment banks were thrilled with this new opportunity in real estate because they weren’t making much money on their traditional business of investment banking and buying and selling securities. By coming up with new ways to package, slice, and dice mortgage securities, Wall Street firms made a boatload of money. Unfortunately, many of these new securities, which provided capital to finance the real estate boom, were highly financed themselves. Effectively, the actual equity that underpinned some of these mortgages was negligible.
When the real estate bubble became unsustainable, just like the earlier technology bubble, it all came crashing down.
With very little equity supporting billions in outstanding mortgages, a slight decline in the value of the real estate caused a ripple effect of delinquencies and defaults. As the defaults spread, it began to feed on itself like a California wildfire inhaling dry timber. Eventually, fear took over as nobody knew when the vicious cycle would be broken. Enter last week.
Investors had weathered blowups from Countrywide, Bear Stearns, Fannie Mae, Freddie Mac, and now, they were facing major problems with Lehman Brothers, AIG, and Merrill Lynch. By week’s end, Lehman had been forced into bankruptcy, AIG had been effectively nationalized by the government, and Merrill Lynch had taken refuge in the arms of Bank of America. This tumultuous turn of events propelled the government to act swiftly and decisively.
The Present
The situation is fluid and changes are happening with lightning speed. Over the weekend, the Bush Administration sent to Congress a $700 billion proposal that would give the Treasury broad authority to purchase distressed assets from U.S. financial institutions in an effort to stem the crisis. The proposal would also raise the nation’s debt ceiling to $11.315 trillion from its current $10.615 trillion limit, according to Bloomberg. To put $700 billion in perspective, that translates into an average bill of $6,500 per U.S. family, according to a report from MarketWatch. Now, it’s possible that the Treasury will turn around and sell the assets and recoup some or all of that $700 billion, but that will not be known for perhaps years.
We also don’t know how hard of a bargain the government will drive when it tries to buy these distressed assets. If it tries to buy the assets at a very low price, then the financial institutions may have to take more write-downs and raise more capital, which could keep this vicious cycle spiraling down. Conversely, if it buys the assets at a high price, then the financial institutions benefit at the expense of the taxpayers who are on the hook for any future losses.
In a surprising twist, investment banks Goldman Sachs and Morgan Stanley announced late Sunday night that they will convert their businesses into traditional bank holding companies, according to The Wall Street Journal. This will subject the companies to new regulatory oversight and possibly significantly reduce their future profit opportunities. It may also put the companies in a better position to be acquired, to merge, or to acquire a smaller bank with insured deposits.
In other news last week, the Treasury announced that it is extending bank deposit-type insurance to money market funds. The news of a money market fund that “broke the buck” prompted the government to implement this safety net as a way to limit further damage in the $3.3 trillion money market industry, according to Bloomberg. Also, on Friday, the Securities and Exchange Commission implemented a ban on short-selling 799 companies through October 2. This may ease some of the pressure on these companies and shield them from “bear raids” that could depress their stock price.
The changes announced by the government late last week helped spark a huge rally in stocks on Thursday and Friday. Nobody knows whether this is just a temporary reprieve or the beginning of a new period of stability.
The Future
As the old saying goes, “Forecasting is the art of saying what will happen, and then explaining why it didn’t,” which is why we will never make a market prediction. To say we live in interesting times would be stating the obvious. We have a war on terrorism; hurricanes; the political silly season; failing financial institutions; soaring, then plunging oil prices; a depressed real estate market; and a myriad of other issues. Yet through it all, we have to find a way to be resilient. Yes, the market is down and it hurts, but for those who are diversified, it’s generally not catastrophic. We remain optimistic that we’ll pull through our current problems and end up stronger down the road. As Americans, that’s the way it’s always been, and we expect that’s the way it will always be.
Tags: bear market, Markets
Posted in Markets | No Comments »
September 13th, 2008 by Ted Toal
In the 3rd grade I used to lean back in my chair, teetering precariously on the two back legs. Not to worry though, I had a plan. If I felt myself tilting backward I would just quickly lean forward and right myself. Not only did I know what I was doing (I was in control), but I had good intuition about when the teacher might turn around. Clearly, I would never be caught and I would never fall backward to the floor. Right?
As you might imagine, I was scolded repeatedly and of course I fell numerous times until I corrected my behavior. Unfortunately, adult investors are not quite as diligent about correcting bad behavior, as they have no hard floor or irate teacher to hold them accountable. As a result, overconfidence and reliance upon intuition play very large roles in the systemic erosion of household portfolio values.
Coupled with the overconfidence issue, is the harsh reality that we are wired completely backwards for proper investment behavior. Stocks must be the only entity that we want to buy more of as prices go up, and get frustrated and sell when prices drop. Can you imagine yourself at a flea market where the guy selling knock-off sunglasses shows you a chart of the sunglass prices over the past six months? The price has marched steadily upwards from $5 to $15 to $25 and now he is proudly offering them for $40. You say to yourself, “Wow, these must be really great sunglasses…look how fast the price is moving up - I better buy 50 pairs before the price goes up even higher.”
The premise sounds ridiculous with sunglasses, but substitute a trendy sounding stock like “Sugar to Ethanol Brazilian Biofuels, Inc.” and all of a sudden there is that urge to scoop up stocks at $40 per share because the price has risen higher and the stock sounds good. Why in the world do we always want to buy stocks after the price has gone up? Somehow we, the investing public, just can’t conceptualize that historical price trends have no statistical relationship to future price movements. Instead, we love to see 5-star funds with upward sloping graphs just because some marketing pros are quick about thrusting them in our face every time an upward trend temporarily appears in some fund, some sector, or in some stock.
Let’s stretch the biofuel example a bit further. I’m certain you know someone who has convinced themselves to buy a stock with a litany of rationalizations similar to: “Biofuels are definitely the future. We’re running out of oil - look how many more people in China and India are going to need oil over the next decade. Sugar to ethanol…that is brilliant - I bet most people don’t even know that’s possible. If oil goes to $200 a barrel this stock is going to be golden. They just opened five new processing stations in Brazil and that economy is doubling every six years. The stock was listed on investopeida.com’s five ethanol trades to make for September.”
However, with perhaps slightly different perspective, what that misguided person is really saying is: “I know something the rest of the investing public does not. I know the market price of this stock is wrong, and it should be much higher. I have better intuition and a better understanding of the future cash flows of start-up Brazilian biofuel companies than other investors. I will take control during this down market by trading my way to better returns. I am one of the very few individuals in control in the unknowable and uncontrollable markets and I will outmaneuver my way to economic bliss. I am smarter than others who participate in the global equities marketplace.”
Think about the ego statement required to buy that stock. I’m certainly not advising anyone whether or not to buy start-up Brazilian biofuel companies. I just want you to be cognizant that overconfidence, intuition, and a lemming-like pursuit of price trends will not help you, or anyone else, accomplish real financial goals. You are taking enormous strides toward patiently building wealth as you cast hubris aside and remain committed to your goals. Do not succumb to the illusion of control that frequent trading gives to others, as you are comfortably positioned for the inevitable market recovery while everyone else will be scrambling to dump their Brazilian biofuel stocks, oil futures, or Chinese technology stocks for half of what they paid.
Tags: investor emotions, investor psychology, Markets
Posted in Newsletters | 1 Comment »
