Market Correction?

It's a confirmed Bull market, baby, you can take it to the bank. The guys in Washington have said the recession, depression, whatever they call it is over and all signals are that this running Bull is going to continue until it blows right through 14000 on the DJIA and head to 36000.

Really, Paul?

Nah, I'm having a little fun, dear reader, because there's been a lot of euphoric talk and whenever I hear grown men giggle and politicians starting to take credit for a job not yet finished I know something not so good is about to happen.

There was a recent article in one of the financial newspapers I receive written by someone who said he knew what he was writing about and he predicted a straight line recovery, an express to the penthouse, because, he said, the market collapsed nose first and it is only logical to assume it'll do the same coming back. It's the old straight down-straight up theory of investment management.

I am here to tell you that this was not a nose first market descent but it took almost a full year and a half. It didn't happen overnight, though we may think it did.

The same was true with the 2000 Internet bubble. It took two years to find a bottom and almost five to move back up before it started to fall apart again.

How do I know this? All you need to do is look at a chart of the S&P 500 and in March 2000 the index was 1527 before it tumbled and in October 2007, its most recent high was 1565 before making the trek down to where it is today. Whoever said that the markets nosedived and would quickly recover the same way has been too lazy to simply look at a chart that clearly indicates a market that took almost 1 1/2 years to find the most recent bottom.

Students of our domestic economy know that recessions last on average 16 months and periods of economic expansion average almost four years before pulling back.

We're almost a decade beyond the folly of the Internet bubble and we've yet to see the return of the NASDAQ high of 5132. No sharp V recovery for that market.

In 2008 the stock market didn't just fall off the cliff in one day. It started in 2007 and weakly crawled into 2008. Back in early 08 we were told that we'd be out of the mild recession by the elections. The experts were wrong and what we had was a bigger mess than 1987 and 2000 combined. This wasn't a sharply etched V but a slow slide that took almost two years to get to where we are.

Expect this recovery to slowly work its way through the mess banks and government created. It took years to make and it'll take another few years to get back where we once were. How do I know this? History, especially in markets, always seems to repeat itself.

A Bit of Good News Goes A Long Way

Professional money managers base their decisions on what to buy and when to buy on cold hard facts. Amateurs, for the most part, do their buying on hope and what their gut tells them. So far the amateurs are leading the markets higher, or so it seems because professionals shouldn't be acting like this.

Lat week the Aussies raised their interest rates and the markets responded by pushing equities, bonds and commodities higher. It's not supposed to work that way. Yes, we've seen the dollar get crushed lately, which should make oil sparkle, since it is traded in dollars. But, we shouldn't be seeing everything going up all at the same time, certainly not bonds and gold.

To give the investor their due their is a lot of money that has been idling on the sidelines and looking to be put to work. Any excuse to jump in seems to work. My concern is that gold is trading at all time high this year. This increase is signaling inflation, and seems to be sustainable while bonds are also holding their own. Bonds, if there is inflation, should be pulling back while gold should keep on trucking. That's not what happened and something has to give. Either we're seeing the a glimmer of inflation or we're not.

Our domestic equities have also held their own, moving higher as the dollar losses ground. Stocks in the S&P 500 are multi-national, meaning they make money here and there and everywhere. A weak dollar works just as well for our domestic based companies as it does for our overseas friends when the dollar goes kaput.

Geithner and Bernanke both agree we need more stimuli to get our economy percolating rather than a rate hike. Unemployment is predicted to hit 12%, home sales and prices are weak, commercial real estate is near life support, retail sales are anemic, workers have not seen their wages increase even though manufacturing had a touch of an increase but just a touch, and to be blunt we're not out of the woods by any stretch of the imagination. Increasing interest rates at this point is probably the last thing on this administration's mind. The economy is still fragile and while the investment folk like to point out that they 'look ahead' six months when making their buying or selling decisions there doesn't appear to be a lot of really great news on the horizon unless you do what the Wall Street folk appear to be doing which is squinting really hard and keeping their fingers and toes crossed.

The Aussie rate hike doesn't look like it'll start any stampede to higher rates by other central banks, although it did give a boost, of a sort, to the markets for a day or so.

Capital Marx

Back in the day, I'm talking 1960s not the dark ages, a lot of professional ball players had to have off-season jobs in order to make a living. They just couldn't make ends-meet with what they earned playing baseball, hockey, football or basketball. When the season ended they painted houses, worked construction and a few even sold life insurance. If the team won a championship it was highly unlikely the player could take the rest of the year off and bask in their celebrity status.

Detroit Tiger Hall of Famer Al Kaline, during his peak years, turned down a contract for six numbers because he didn't think he was worth it. Today some ball players get paid that much in a week and couldn't carry Kaline's dirty socks.

Which brings me to today's rant and the compensation of some corporate CEOs and the lack of value they bring to shareholders. These are the leaders that only know how to increase their corporate bottom line by firing employees, slashing benefits and selling off divisions. For this the top-level execs are compensated extravagantly and totally out of whack with reality.

Neill Minow, co-founder of The Corporate Library, an independent research firm, met with Treasury Secretary Geithner this past summer to discuss this exact subject of executive compensation.

She talked to Geithner about what the management at Citigroup was planning, earlier this year, to increase compensation to certain employees by 50% because of government mandated reduced bonuses. This was sort of a mulligan for loyal execs. Citi, which was close to first in line for TARP, and now a wholly owned government subsidiary, is not the only company not caring about shareholder value. Minow proclaimed that what Citi planned on doing was, '...doing more to destroy capitalism than Marx.'

A.I.G., another bailout poster child paid out $165 million to employees in the financial services division, the same folk who helped bring us the 2008-2009 recession. How does anyone justify this, asks Minow.

Many of us remember the lack of responsibility and run-away destruction at K-Mart that destroyed the retirement of thousands of employees and left shareholders with nothing. Not only was the leadership incompetent the same was true of the Board of Directors that did nothing to stop the corporation's eventual bankruptcy.

Minow has made significant leadership changes at American Express, Kodak, Waste Management and confronted Sears to implement improvements in their company's stock plan.
Manow cannot do this work alone. As investors it is our responsibility to ensure that we invest in companies that are responsible in all phases of their business and if we buy mutual funds to make sure that fund management is pro-active in demanding CEO and Board of Director accountability.

Failing that as consumers we vote with our pocketbooks and that certainly is something all businesses understand.

Sophisticated Confusion

There is a lot of talking head quasi-professional-technical advice being given on how the average investor should manage his or her savings. The difference between success and failure it seems is in the minutia. From talk radio to cable television here are some of the things being said on how to manage our money: Buy and hold is dead. Exchange Traded Funds are better than mutual funds. Watch bonds for signals to where the economy is headed. The Transport Index is a leading indicator of the future. Tech is always the bellwether indicator. Bio's surge when the market falters. The list goes on.

Most successful investors keep things simple, understand what they own and don't drive themselves nuts by checking their accounts every day. Warren Buffet once said that he doesn't look at his personal investments but a few times a year. He said you don't check the value of your home more than that then why do it with your stocks and mutual funds?

One of my pet peeves is running into someone who's asset allocated their $25,000 401(k) portfolio into about eight slices, and wants each piece to be a consistent winner, each and every day. When I explain they would do just as well with one good world fund that pays a dividend they look at me as if I just escaped a padded room.

The truth is most average investors can do just as well be settling on a portfolio of domestic, foreign and bonds funds. If you want to simplify it more create a design using a world fund that pays a dividend and add an intermediate bond fund. If you're 50-years of age a basic 50-50 allocation into those two funds will do just as well as anything complicated some money management firm cranks out and charges a huge annual fee.

No matter what anyone tells you, dear reader, there is no such thing as a perfect investment plan. Keep it simple, adjust it as time goes on and understand what you own.

Investing, in some ways is like romance. There are those that spend their entire lives looking for their soul mate and there are others who simply find someone they can be comfortable with. Those that spend their lives looking for their soul mate are consistently disappointed while those that settle never are.

Understanding Risk

Defining investment risk us as nebulous as defining time. We can get our minds around the basic concept but have trouble communicating what we mean.

For one person defining themselves as being a conservative investor may mean that they invest their money in cash and cash equivalents. Another investor it may mean burying money under the front porch in an old mayonnaise jar. Still another it could be to invest in equities that have significant less risk than the market. When attempting to communicate exactly what they mean by their definition of being a conservative investor to their stockbroker or financial planner the differences in risk and volatility can be significant even though they all use the same word it means something different to each of them.

To define the amount of risk an investor is comfortable assuming there are helpful methods that money management firms have designed. The most common are professionally designed risk questionnaires. The problem is that investors have to answer the questions, and that involves individual subjectivity.

And it's that subjectivity defining their investment risk is what gets investors and their planners in trouble. People with conservative tendencies have told me that their planner thinks that they should be investing in an S&P 500 mutual fund and that will achieve their goals in actual return and in relative emotional comfort. That's planner subjectivity, or ignorance, and is a time bomb waiting to explode.

To clarify what we mean the entire process of understanding risk to return can be dealt with by simply asking, 'How much return on investment am I happy making on a consistent basis and how much am I willing to lose if the markets suddenly go south?'

It should be that simple. And if more people did just that we would have a lot less problems, arbitrators and lawyers clogging up valuable investment management space and time.

Here's what you do - write your goals on a 3x5 card and tape it somewhere where you can see it everyday to remind yourself what you want to earn consistently on your investments and what price you're willing to pay when things go wrong. Stick with your written goals no matter what, during good times and especially bad. And, in case you still don't get it, things will go terribly wrong many times in your investment lifetime no matter how many rules and regulations the government creates and enforces.

What Roubini Said

Nouriel Roubini, a well-respected economist, who, some financial experts say, correctly predicted the magnitude of the financial meltdown, is not too optimistic about our economic growth for the next few years. Roubini, who spoke at the Reuters 2009 Investment Outlook Summit in New York, said the United States would experience a U-shaped recovery, where growth would remain relatively flat, or below the historical trend, for several years and then recover. He is, however, bullish on emerging markets.

Attending the Reuters conference were 51 economists from around the world. About two-thirds of those agreed with Roubini while the others felt we would be having a much more robust recovery, representing a V shape rather than a U. According to Reuters, the forecasters expected little inflationary trends but a 'stubbornly' high unemployment rate through 2010.

In the September 7th Barrons Myles Zyblock of RBC Capital Markets said of the past markets move that, 'The market is digesting a lot of gains and it won't take much to trigger a correction.' Barclay;s Barry Knapp believes that a possible 8.5% downside before year-end is in the offing. Others thought a possible 15% correction by the middle of October was in the technical charts.

But, the good news and consensus is that the possible correction will be shallow and short. The S&P 500 low of 676 will be, according to the experts, a 'generational' threshold. Which is a nice way of saying it won't happen again any time soon and we can tell our grandkids where we were when the markets almost imploded.

Still, looking forward, the experts are factoring in higher multiples, saying that the market can indeed go higher.

And, what if you want to make a mutual fund investment in a non-qualified account for this quarter? I would wait until after any capital gains were paid out by the mutual fund before making that investment. It doesn't make sense to buy a fund have to pay taxes on the capital gain distribution and see you money take a possible hit before the end of the year. Also, if the experts are right you may be able to buy that fund later at a cheaper share price.

Schmart Too Late

It seems like only yesterday that investors and investment managers were fawning over the Harvard Management Company, the folks who manage the endowments for one of America's premier universities. Businessweek magazine, among others, bragged on how the geniuses at Harvard Management spread the money among a wide range of exotic assets including hedge funds, commodities, foreign bonds, TIPS and their favorite - timber.

Articles gushed how private investors could learn a thing or three about allocating their investments like the folks at Harvard Management.

Recently financial planning magazines exhorted the lowly registered representative (meaning me and a few other people) to adopt a similar allocation policy entitled 'Tactical Asset Allocation', the new-new thing that is surely the answer to what failed us recently and similar to the Harvard model. Only Harvard got hit just like everyone else. Losses were in excess of 30% in the past 12 months and the university was forced to borrow 1.5 billion dollars because of hard to sell assets - just the kind of assets they loved to pieces a few years back.

Now Harvard and their new management team is back at the drawing board, pulling in their far-flung investment managers and thinking liquid, less expensive and liquid.

It's times like this that Jack Bogle, found of the Vanguard Funds, seems like a genius, buying bonds and domestic stocks in two mutual funds and allocating his fixed income by the same percentage as his age. Cheap. Liquid. Effective.

There will always be new fangled ways to manage money. For a time some of these methods will be able to make gains but in the end it's the basics that count. Harvard Management, with some of the smartest people in the world on their staff, is just coming to that conclusion.

Simple often works better.