Where do Wall Street's mega-profits come from? With free lunches still a myth, it stands to reason those truckloads of dollars have to come from somewhere and someone. With the market wobbly and regulatory reform in the headlines, the question is more important than ever. Especially the question of who the chumps may be.
In this era of bank bailout bonanzas, we know that taxpayers rank high among the chumps. They saved the banking system, and bankers took home the beef--and the lobster, shrimp cocktail, caviar, champagne, and cognac. As middle class taxpayers struggle to keep up with the costs of subsidizing Wall Street, the banks' lobbying blitzkrieg rampages through the halls of Congress in a fairly successful effort to prevent meaningful regulatory reform. For the mostly wealthy people running the financial system, it is apparently better to receive than give.
Customers are a prominent source of Wall Street's profits. The big banks' lobbying scrum in Congress to combat transparency in the derivatives markets aims to protect outsized markups and markdowns that customers can't see. If they can't see these expenses, they can't negotiate very well. Even though customers in the derivatives markets are institutions, they for the most part trade with investor money, like pension contributions, 401(k) contributions, and so on. Markups, markdowns and other transaction costs they incur ultimately come out of investor pockets in the form of lower returns. If derivatives customers are business corporations, then those costs come out of the pockets of shareholders or the customers of the business corporations (in the form of higher prices). As we noted, there still ain't no such thing as a free lunch.
Even in relatively transparent securities markets, such as the mutual fund market, the investor is sold the Brooklyn Bridge. Counterintuitively, mutual fund fees tend to rise the larger funds become. This is true for both stock funds and bond funds. Things were supposed work the other way around. We were told that larger funds would use economies of scale to reduce fees and pass more gains onto investors. However, the mutual fund industry also seems to believe that receiving is better than giving. There are a few exceptions, often in the cases of index funds. But most money managers appear to have captured the benefits of economies of scale for themselves.
The outsized profits of big banks in recent recession years and the increase in mutual fund fees even as funds get larger imply that the relatively high level of concentration in the securities industry is another reason for bankers' big pay days. Businesses love monopolies and oligopolies, and fight governmental efforts to curtail concentration. Some of the biggest lobbying fights in the financial reform arena have been aimed at suppressing measures that would require the big banks to split up, and lose some of their market power. On the other hand, a measure that would protect big banks, concentrating regulatory power in the Fed (which sees size as a regulatory advantage, and which has a long history of brushing aside the interests of retail customers) has pretty much become a certainty. If you don't like Microsoft, you won't like the big banks (and the Fed) because oligopoly in the financial services industry appears to be in our future.
Even do-it-yourself individual investors who frugally stick to index funds and the lowest cost online brokers pay part of the price. They add liquidity to the market and make it easier for the big firms to trade and sell stock and ETF offerings. But what returns do these investors get? The Dow Jones Industrial Average is trading at 1999 levels, if you look at its numerical value. Factor inflation into the picture and the time machine takes you back to 1997, when Monica wasn't a name associated with Presidential scandal. A passbook savings account would have been more profitable.
When an industry imitates the Sheriff of Nottingham, counting 12 for itself and 1 for the poor (which by this count would be just about everyone else), it can only expect ire, taxation and regulation. But potentially far worse would be the loss of customers. The recent bull market was notable for the absence of individual investors. Indeed, one of the quirks of the recent downturn is that it wasn't preceded by a rush of Mom and Pop investors jumping in at the top. Mom and Pop, now the tired, drawn Ma and Pa of Grant Wood's American Gothic, have smartened up about playing on a freeway filled with tractor-trailers driven by overpaid bankers. They're sticking to the farm and to simple investments. Something complex and unpredictable like stocks (and there's no arguing after the Flash Crash that the stock market has become more mysterious and unpredictable over the years, not less so) is left for gamblers and naive dreamers.
Individual investors have been the golden goose for the stock market. Through mutual fund investments and direct stock purchases, they are a major source of savings, the true capital of Wall Street. Without managed money to play with, the big firms could hardly make a fraction of the profits they enjoy. Individual investors are less well informed, and thus easier marks. Many of them hold investments for long periods of time, providing stability while Wall Streeters trade in and out in frantic and often unsuccessful efforts to beat the S&P 500. Without these vasts herds of retail sheep to shear, the big firms would only have each other to snipe at. That would be tough going and far less profitable.
Of course, enormous amounts of capital are invested in stocks because of financial plans already in place. Much (but certainly not all) 401(k) money will stream into stocks. But Wall Street ultimately needs big growth for its big pay days. And the growth goose may not fly again for a generation or more.
Showing posts with label Investing in Volatile Times. Show all posts
Showing posts with label Investing in Volatile Times. Show all posts
Thursday, June 10, 2010
Monday, May 31, 2010
Defense May Be the Best Offense in the Financial Markets
Individual investors largely sat out the most recent bull market, and the wisdom of the crowd seems to have been vindicated. The Euro zone is the latest debt-fueled asset bubble to pop. The 16 nations that use the Euro are being forced by skittish creditors to deleverage. Since the European Central Bank won't deliberately weaken the Euro (and may be quietly supporting it through sovereign debt purchases in the secondary market), Euro bloc governments have to cut spending. Some may even have to restructure their debt (although none will admit to that). The U.K., with Europe's largest economy outside the Euro bloc, is also retrenching.
In Asia, China is trying to rein in overheated asset markets. North Korea's bellicosity frightens cash into bank accounts. The war in Afghanistan grinds on, with no clear end in sight. Although Asia's emerging economies (i.e., excluding stagnant Japan) are in growth mode, they are too small a bunch of ponies to pull the huge, lumbering wagon that is the combination of the European and North American economies. (China, India, South Korea and the other emerging economies in Asia combined barely total a quarter of Europe and the U.S. together.)
More Sisyphean than the Afghanistan war is the British Petroleum oil spill in the Gulf of Mexico. Nothing has stopped the outflow. Even though yet another temporary fix is being attempted, there is apparently no hope of a permanent solution until August. The amount spilled is in dispute, but there's no doubt it's a lot. Oil is not only spreading throughout the Gulf states, but may come up the East Coast of the U.S. in the Gulf stream. At some point, the spill will discernibly slow U.S. economic growth, and that point could be close.
That said, the U.S. economy keeps growing, at a moderate rate that has pretty much been imputed in stock market valuations. More moderately good news won't revive the bull. There's no indication of a large economic stimulus in the future. With the recession over from a statistical standpoint, and populism surging from sea to shining sea, there isn't enough political support for another spendapalooza by the U.S. government. The Fed can't lower interest rates below the zero level where they now are, and may have to soon begin selling off some of the trillions of dollars of mortgage-backed assets it reluctantly holds.
All in all, this may be a good time for investors to play defense. Be cautious about putting new cash into the market. Ease back on equity exposure if you're losing sleep over downside risk. Since stocks are no higher than they were in 1999 (or 1997 if you consider inflation), there isn't a strong argument that you need always need a large proportion of your portfolio in stocks.
Cash has a beauty that becomes luminescent in uncertain times. Fraidy cats who kept their money in passbook savings during the last decade proved more perspicacious than most professional money managers and most stock market investors. Intelligent and rational people can look at the stock market and reasonably opine it's a looney bin.
That's not to say that stocks need be shunned like a carrier of typhoid. Defense can serve as the foundation for offense. Build up cash and keep it ready for use. If stock values fall to attractive levels, consider buying. Don't think you can time the market perfectly. But with a lot of conventional investment wisdom upended by the volatility of today's big bank, big investor centric market (i.e., the market being of big money, by big money and for big money), it's hard to contend that market timing should be counted as a cardinal sin.
Like all else, however, sin in moderation. Invest only a small proportion of your available cash at a time. Think in terms of cost averaging, not hitting a home run. If the market continues to look attractive, infuse more cash bit by bit. Don't get discouraged if the market declines again. Use the further decline as an opportunity to feed a little more cash into the market. Unless civilization ends (and the combined military strength of North Korea, Iran, al Queda and the Taliban can't end civilization; the recklessness and greed of bankers presents a greater risk), your investments will become profitable eventually.
In Asia, China is trying to rein in overheated asset markets. North Korea's bellicosity frightens cash into bank accounts. The war in Afghanistan grinds on, with no clear end in sight. Although Asia's emerging economies (i.e., excluding stagnant Japan) are in growth mode, they are too small a bunch of ponies to pull the huge, lumbering wagon that is the combination of the European and North American economies. (China, India, South Korea and the other emerging economies in Asia combined barely total a quarter of Europe and the U.S. together.)
More Sisyphean than the Afghanistan war is the British Petroleum oil spill in the Gulf of Mexico. Nothing has stopped the outflow. Even though yet another temporary fix is being attempted, there is apparently no hope of a permanent solution until August. The amount spilled is in dispute, but there's no doubt it's a lot. Oil is not only spreading throughout the Gulf states, but may come up the East Coast of the U.S. in the Gulf stream. At some point, the spill will discernibly slow U.S. economic growth, and that point could be close.
That said, the U.S. economy keeps growing, at a moderate rate that has pretty much been imputed in stock market valuations. More moderately good news won't revive the bull. There's no indication of a large economic stimulus in the future. With the recession over from a statistical standpoint, and populism surging from sea to shining sea, there isn't enough political support for another spendapalooza by the U.S. government. The Fed can't lower interest rates below the zero level where they now are, and may have to soon begin selling off some of the trillions of dollars of mortgage-backed assets it reluctantly holds.
All in all, this may be a good time for investors to play defense. Be cautious about putting new cash into the market. Ease back on equity exposure if you're losing sleep over downside risk. Since stocks are no higher than they were in 1999 (or 1997 if you consider inflation), there isn't a strong argument that you need always need a large proportion of your portfolio in stocks.
Cash has a beauty that becomes luminescent in uncertain times. Fraidy cats who kept their money in passbook savings during the last decade proved more perspicacious than most professional money managers and most stock market investors. Intelligent and rational people can look at the stock market and reasonably opine it's a looney bin.
That's not to say that stocks need be shunned like a carrier of typhoid. Defense can serve as the foundation for offense. Build up cash and keep it ready for use. If stock values fall to attractive levels, consider buying. Don't think you can time the market perfectly. But with a lot of conventional investment wisdom upended by the volatility of today's big bank, big investor centric market (i.e., the market being of big money, by big money and for big money), it's hard to contend that market timing should be counted as a cardinal sin.
Like all else, however, sin in moderation. Invest only a small proportion of your available cash at a time. Think in terms of cost averaging, not hitting a home run. If the market continues to look attractive, infuse more cash bit by bit. Don't get discouraged if the market declines again. Use the further decline as an opportunity to feed a little more cash into the market. Unless civilization ends (and the combined military strength of North Korea, Iran, al Queda and the Taliban can't end civilization; the recklessness and greed of bankers presents a greater risk), your investments will become profitable eventually.
Tuesday, November 3, 2009
Investing Hint: Sometimes, Just Say No
So where do you put your money now? Stocks are uneasy, Treasuries are slipping back, gold and oil are dicey, and real estate is unpredictable. Corporate and muni bonds may be okay, but you have to be careful and selective. Simply buying a corporate or muni bond fund may get you a lot of garbage as well as gems. Asia, especially China, has enjoyed good economic growth, so perhaps you think Asian stocks might be a good bet. But one wonders whether the carry trade, now consisting of borrowing U.S. dollars at dirt cheap interest rates and converting them into another currency for investment overseas, isn't responsible for a lot of the pop in Asia. If so, it would be nice that the Federal Reserve is financing much of the resurgence in Asia. But the Fed may gradually withdraw its accommodation. And Asia remains export driven; it will be dependent on a strong U.S. recovery for long term growth, and few are expecting the U.S. to be the consumption wonder it was earlier this decade.
Sometimes, there are few or even no good investments. The fall of 2008 was one such time, when numerous investors came to understand why their grandfathers of the Depression era liked so much to carry a roll of $200 or $300 in their pockets. Cash felt good.
We may be entering such a time period now. There's nothing on the investment horizon that looks like a screaming buy. There isn't much that looks more than tepid. There's no law of investing that says you have be fully invested. Holding some or even a lot of cash is perfectly okay. Mutual fund and hedge fund managers often feel they need to be fully invested. But that's because they compete against other professionals. They don't want to run the risk of missing a rally and doing less well than other professionals. If a professional money manager stays fully invested and crashes into a bear market instead, that's usually not as bad because numerous other money managers suffered the same losses from also being fully invested. Just remember that most professional money managers don't even manage to beat broad market indexes like the S&P 500. So if you want to pretty much ensure that you won't keep up with the market as a whole, stay fully invested like the other losers.
If you have some uninvested cash, this may be a time to just say no to new investments. Take your time and wait for a good opportunity. If you hold cash for a year and miss out of turbulent markets, you may be better off. Even with this year's rally, the stock market is where it was in 1999, without adjusting for inflation. That's ten years of no gains (and indeed losses if you factor in inflation). If you had taken all your available capital in 1999 and put it in a money market fund, you'd be ahead today by a nontrivial amount. In the last ten years, the nervous Nellie turtles have beaten the hare.
Holding cash isn't a long term investing strategy, and it's advisable to go back into stocks, bonds and perhaps other investments eventually. This, of course, involves some market timing. But, notwithstanding all the expert advice against market timing, large swaths of the investing public do it. So do highly successful investors like Warren Buffet, and more recently John Paulson. There's no guarantee that holding cash now and for the next six, twelve or however many months will be more profitable than diving into something or other. But trying too hard can lead to mistakes. If you aren't sure that the goose you're looking at will lay golden eggs, keep your cards close to your vest and play them when the odds look better.
Sometimes, there are few or even no good investments. The fall of 2008 was one such time, when numerous investors came to understand why their grandfathers of the Depression era liked so much to carry a roll of $200 or $300 in their pockets. Cash felt good.
We may be entering such a time period now. There's nothing on the investment horizon that looks like a screaming buy. There isn't much that looks more than tepid. There's no law of investing that says you have be fully invested. Holding some or even a lot of cash is perfectly okay. Mutual fund and hedge fund managers often feel they need to be fully invested. But that's because they compete against other professionals. They don't want to run the risk of missing a rally and doing less well than other professionals. If a professional money manager stays fully invested and crashes into a bear market instead, that's usually not as bad because numerous other money managers suffered the same losses from also being fully invested. Just remember that most professional money managers don't even manage to beat broad market indexes like the S&P 500. So if you want to pretty much ensure that you won't keep up with the market as a whole, stay fully invested like the other losers.
If you have some uninvested cash, this may be a time to just say no to new investments. Take your time and wait for a good opportunity. If you hold cash for a year and miss out of turbulent markets, you may be better off. Even with this year's rally, the stock market is where it was in 1999, without adjusting for inflation. That's ten years of no gains (and indeed losses if you factor in inflation). If you had taken all your available capital in 1999 and put it in a money market fund, you'd be ahead today by a nontrivial amount. In the last ten years, the nervous Nellie turtles have beaten the hare.
Holding cash isn't a long term investing strategy, and it's advisable to go back into stocks, bonds and perhaps other investments eventually. This, of course, involves some market timing. But, notwithstanding all the expert advice against market timing, large swaths of the investing public do it. So do highly successful investors like Warren Buffet, and more recently John Paulson. There's no guarantee that holding cash now and for the next six, twelve or however many months will be more profitable than diving into something or other. But trying too hard can lead to mistakes. If you aren't sure that the goose you're looking at will lay golden eggs, keep your cards close to your vest and play them when the odds look better.
Saturday, October 3, 2009
Why It Feels So Rough in the Stock Markets
If investing in stocks feels like you're riding through white water, you're not imagining things. It is rough in the market. Let's look at the data.
The 1920s were a period of secular, or long term, market rise. Then, the 1929 market crash knocked the market for such a loop that it did not recover on an inflation adjusted basis until 1953. Then the market enjoyed a secular rise until the end of 1972. However, with the malaise of the 1970s setting in, the market fell and did not recover on an inflation adjusted basis until 1991. Between 1991 and early 2000, the market rose on a long term basis. However, after peaking in March and April 2000, the market has never fully recovered. Currently, adjusted for inflation, the market is at 1997 levels; it's gone nowhere for the past 12 years.
In all, since 1920, the stock market has, on a long term basis, risen a total of 37 years. It has been in a losing position (compared to the preceding peak and adjusted for inflation) for a total of 50 years. No wonder stock market investing makes a lot of people seasick.
Of course, the good years saw gains that greatly exceeded the losses in seasick years. Overall, since 1920, the market has been a very good investment on a long term basis. But, as John Kenneth Galbraith put it, in the long term we're all dead. If your time horizon is about 15 or 20 years, you should be cautious with stocks. Some equity exposure is prudent, because there will be mid and short term rallies even during long term downturns. But you should use bonds or comparable investments to stabilize the value of your portfolio. If your time horizon is short, like a few years or less, it's best to step back from stocks. You may miss out on some gains. But you don't want to lose your child's college tuition money, the down payment on your house, or the funds for Mom or Dad's assisted living expenses.
Even though diversification isn't a bulletproof investment strategy, it still makes sense for many people on a long term basis. If you're taking too many painkillers because of your stock investments, reduce your equity exposure. Put it all in bank CDs if that let's you sleep. Keep your portfolio simple. (See http://blogger.uncleleosden.com/2009/04/investing-in-discouraging-times-can-be.html.) Whatever you do, don't stop saving. People who don't prepare for the future won't have much of one.
The 1920s were a period of secular, or long term, market rise. Then, the 1929 market crash knocked the market for such a loop that it did not recover on an inflation adjusted basis until 1953. Then the market enjoyed a secular rise until the end of 1972. However, with the malaise of the 1970s setting in, the market fell and did not recover on an inflation adjusted basis until 1991. Between 1991 and early 2000, the market rose on a long term basis. However, after peaking in March and April 2000, the market has never fully recovered. Currently, adjusted for inflation, the market is at 1997 levels; it's gone nowhere for the past 12 years.
In all, since 1920, the stock market has, on a long term basis, risen a total of 37 years. It has been in a losing position (compared to the preceding peak and adjusted for inflation) for a total of 50 years. No wonder stock market investing makes a lot of people seasick.
Of course, the good years saw gains that greatly exceeded the losses in seasick years. Overall, since 1920, the market has been a very good investment on a long term basis. But, as John Kenneth Galbraith put it, in the long term we're all dead. If your time horizon is about 15 or 20 years, you should be cautious with stocks. Some equity exposure is prudent, because there will be mid and short term rallies even during long term downturns. But you should use bonds or comparable investments to stabilize the value of your portfolio. If your time horizon is short, like a few years or less, it's best to step back from stocks. You may miss out on some gains. But you don't want to lose your child's college tuition money, the down payment on your house, or the funds for Mom or Dad's assisted living expenses.
Even though diversification isn't a bulletproof investment strategy, it still makes sense for many people on a long term basis. If you're taking too many painkillers because of your stock investments, reduce your equity exposure. Put it all in bank CDs if that let's you sleep. Keep your portfolio simple. (See http://blogger.uncleleosden.com/2009/04/investing-in-discouraging-times-can-be.html.) Whatever you do, don't stop saving. People who don't prepare for the future won't have much of one.
Wednesday, September 12, 2007
Investing in Volatile Times
With the markets turning bipolar, and a bank or two being bailed out every week, investors are understandably nervous. Different asset classes take turns losing value. Investments thought to be safe, like money market funds, turn out to hold asset-backed commercial paper, a security some now deem toxic. Information about the extent of the subprime mortgage and related messes is inadequate. In these times of confusion and incomplete information, many market participants may be buying and selling for the wrong reasons. That only increases the seeming irrationality of the markets.
What’s an investor to do? Here are a few ideas.
1. Diversify. If you can’t reasonably predict which assets will rise and which will fall, diversification allows you to use gains from rising assets to offset losses from falling assets. Your portfolio’s volatility will be muted, and your antacid budget reduced. Diversification is also the sensible way to invest for the long term, so you’re doing your retirement planning a good turn.
2. Dollar-cost averaging. A standard investment technique is to invest a fixed amount of money at regular intervals. The bi-weekly or monthly contribution you make to your 401(k) or equivalent retirement account is a good example of this approach. By investing a fixed amount at regular intervals, you average out the costs of your investments and avoid the risks of trying to time the market. Most investors (and many professional money managers) are not very good at timing the market. Given the long term historical rise of the stock markets, it makes sense to stay in the game. Dollar-cost averaging ensures that you do so without having to guess which fork in the road the market will take tomorrow.
3. Ease back from 80 mph. Another way to reduce the volatility of your portfolio is to make it more conservative. Stick to well-established investments built around benchmarks you understand—index funds, short or medium term bond funds, and money markets. Or go with a lifecycle or target date retirement fund. These funds are long term investment vehicles where the fund managers do the diversification for you. Because they are retirement-oriented, they generally aren’t loaded with risk. Instead, they tend to stick to meat-and-potatoes funds for their equity exposure. See our discussion of lifecycle funds at http://blogger.uncleleosden.com/2007/05/investing-made-simple.html. Conservative investments may, in fact, do well in the next few years. Risk is being re-priced, and low risk investments may be relatively valuable for a while.
4. Save whichever way you can. If you really can’t stomach the ups and downs and uncertainties of the financial markets, put your money into safe, short term investments like money market funds, credit union and bank CDs, and high interest rate online bank accounts. See our earlier blog for suggestions about short term investments. http://blogger.uncleleosden.com/2007/05/investing-for-short-term.html. If you’re concerned about interest rates dropping, buy a CD with a term of several years, or U.S. Treasury notes with similar maturities. That way, you’ll lock in current rates. This strategy could turn against you if interest rates rise (which isn’t forecast by most seers, but the one thing that’s certain is you never know for sure). With the uncertainties of the times, ensuring that you save, however conservatively, remains a smart move. If the only way you can bring yourself to save is to put your money into today’s equivalent of the mattress, then go for it. Maybe, when things calm down a bit, you can diversify. But the worst thing to do is to stop saving.
Entertainment News: read about the air guitar champ. http://www.wtop.com/?nid=456&sid=1242515.
What’s an investor to do? Here are a few ideas.
1. Diversify. If you can’t reasonably predict which assets will rise and which will fall, diversification allows you to use gains from rising assets to offset losses from falling assets. Your portfolio’s volatility will be muted, and your antacid budget reduced. Diversification is also the sensible way to invest for the long term, so you’re doing your retirement planning a good turn.
2. Dollar-cost averaging. A standard investment technique is to invest a fixed amount of money at regular intervals. The bi-weekly or monthly contribution you make to your 401(k) or equivalent retirement account is a good example of this approach. By investing a fixed amount at regular intervals, you average out the costs of your investments and avoid the risks of trying to time the market. Most investors (and many professional money managers) are not very good at timing the market. Given the long term historical rise of the stock markets, it makes sense to stay in the game. Dollar-cost averaging ensures that you do so without having to guess which fork in the road the market will take tomorrow.
3. Ease back from 80 mph. Another way to reduce the volatility of your portfolio is to make it more conservative. Stick to well-established investments built around benchmarks you understand—index funds, short or medium term bond funds, and money markets. Or go with a lifecycle or target date retirement fund. These funds are long term investment vehicles where the fund managers do the diversification for you. Because they are retirement-oriented, they generally aren’t loaded with risk. Instead, they tend to stick to meat-and-potatoes funds for their equity exposure. See our discussion of lifecycle funds at http://blogger.uncleleosden.com/2007/05/investing-made-simple.html. Conservative investments may, in fact, do well in the next few years. Risk is being re-priced, and low risk investments may be relatively valuable for a while.
4. Save whichever way you can. If you really can’t stomach the ups and downs and uncertainties of the financial markets, put your money into safe, short term investments like money market funds, credit union and bank CDs, and high interest rate online bank accounts. See our earlier blog for suggestions about short term investments. http://blogger.uncleleosden.com/2007/05/investing-for-short-term.html. If you’re concerned about interest rates dropping, buy a CD with a term of several years, or U.S. Treasury notes with similar maturities. That way, you’ll lock in current rates. This strategy could turn against you if interest rates rise (which isn’t forecast by most seers, but the one thing that’s certain is you never know for sure). With the uncertainties of the times, ensuring that you save, however conservatively, remains a smart move. If the only way you can bring yourself to save is to put your money into today’s equivalent of the mattress, then go for it. Maybe, when things calm down a bit, you can diversify. But the worst thing to do is to stop saving.
Entertainment News: read about the air guitar champ. http://www.wtop.com/?nid=456&sid=1242515.
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