Bruce's Blog: Wiener Financial Management

News & Notes

 

Seeing Causality When It's Not There

 

Just because two events happen contemporaneously does not mean one of them caused the other to occur.  We love to see causality and connect things that are not necessarily related.

 

Musical Treat

Thinking of causality led me to the word "because," which in turn brought the song "Because the NIght" to mind.  The song was co-written by Bruce Springsteen and Patti Smith.  Patti Smith kills the song, but the Boss, who's pretty ripped in the video, doesn't do a bad rendition himself.

News & Notes

Investment Tricks You Can Do

at Home

 

Watch the video to learn how to analyze investment risk without any real knowledge of the underlying investment.  Impress your friends! 

  

Just remember, 10 year Treasury bonds are currently paying around 2% interest.  So the only reason someone would offer you  a 12% yield is to induce you to take on the added risk.  They are not paying such a huge premium above Treasuries because they love you.

 

Musical Treat

Hopefully, with the discussion above, you Won't Get Fooled Again.  It's amazing how this song is 40 years old and yet its lyrics are still relevant today.

News & Notes

Yucky Tax Stuff

 

Nothing says stop reading further than the word "tax."  Nonetheless, please take 60 seconds to quickly review the following important information.

Your friends at the IRS have imposed new requirements on the companies that hold your investments (think Schwab, Merrill Lynch, etc.).  These custodians must now report the cost basis for certain stocks sold during 2011 and for other types of investments beginning in 2012.  Because of this, the Form 1099 that you receive each year from custodians will be different than in the past.

Moreover, custodians will now default to using the first-in, first-out (FIFO) method for determining cost basis for the sale of stocks unless you tell them in writing otherwise.  (Oh no!  You haven't taken accounting since your sophomore year of college and you weren't quite sure what FIFO meant back then.)  The default method for mutual funds is average cost.

Has your head exploded yet?  If not, please continue to see what this means to you:

1.  Your custodian's Form 1099 will include items arising from the sale of securities, some of which will be reported to the IRS and some of which will not.  You are nonetheless responsible for making sure all taxable events are reported to the IRS.

2.  Your financial advisor may provide you with information regarding the gains and losses incurred as a result of the sale of your investments.  You should make sure that this information is consistent with your custodian's Form 1099.

3.  Don't worry.  Your accountant and financial advisor can assist you with any questions.  This is why you hire them.  Make sure you discuss how you want your custodian to keep track of cost basis going forward.

If you are interested in learning the nitty-gritty details, you can see what Schwab, Fidelity, and Vanguard have to say about these matters.


Words of Wisdom

The hardest thing in the world to understand is income tax. -- Albert Einstein

 

News & Notes

When Price Doesn't Matter

 

I occasionally view things differently than my wife, for which I take full responsibility and repent the error of my ways.  For example, I do not fully appreciate a good bargain.  When my wife buys an item for $50 that was originally $300, I do not share her enthusiasm, although I express my pleasure at her good fortune.  To me, either the item was worth $50 or it wasn't -- it's previous price is irrelevant.

With investments, the purchase price can get in your way of clear analysis.  Let's say you bought the XYZ stock a few months ago for $100 per share and it now trades at $70.  Should you sell it?  Well, there are numerous factors that go into such a decision.  Does it make a difference that you bought the stock for $100 per share?  Absolutely not!

Putting aside tax considerations, the only price that matters is the current one.  You need to determine whether the XYZ stock remains a good investment going forward at $70 per share or whether your money would be better invested someplace else.  

The original purchase price simply clouds our thinking about the future.  The prospects of the XYZ stock today has nothing to do with what we bought it for in the past.  We hate to admit that we purchased a loser.  Many investors say to themselves: "I'll wait until the stock recovers to $100 before I'll sell it."  Yet, the XYZ stock may never get back to $100 per share or it may take decades to do so.  Why hang on to an unattractive stock when better investments may exist?

This means that you are ultimately "buying" the XYZ stock every day you hold it.  By retaining the XYZ stock, you are saying that it is a good value at its current price relative to its future prospects and that there are not other, more attractive, alternatives available.  While institutional money managers may think like this, the average investor likely finds this daily process of analysis too overwhelming.  That doesn't mean, however, that the concept is not worth considering.

Words of Wisdom

My wife will buy anything marked down.  Last year she bought an escalator.
-- Henny Youngman

[Editor's Note: Henny Youngman is from a different era and we in no way endorse any sexism in his quote.]

News & Notes

On the Sexual Revolution

and the Decline of the West

 

When did the sexual revolution begin?  A recent book describes Wilhelm Reich, a student of Sigmund Freud, as the father of the sexual revolution in the 1920's. Another new book claims that the sexual revolution commenced in the1860's in England during the stuffy Victorian era.  Of course, both of these arguments fail to give any credence to the antics of the Hell-Fire Club in London during the late 1700's. 

Ariel Levy writes in The New Yorker how each generation views themselves as having stumbled upon something new.  Such an approach often arises from the conceit of youth -- they are unaware of what preceded them; instead, they focus on how they are breaking free from the social constraints of the day.

While the "founders" of the sexual revolution believed they were exploring a new world unfettered by the restrictions of their ancestors, there exists another group of people who look fondly on the past as they predict a ruinous future.  They are "declinists" -- people who foresee the end of the world as we know it.

Adam Gopnik of The New Yorker explains, however, that those who predict the imminent decline of the West face an immediate hurdle.  Such declinists predicate their gloomy view of the future on the same intellectual ground of those who have previously predicted such a decline.  Thus, present day declinists must "grapple with the tricky point of insisting that the previous era was actually a peak rather than the valley that the previous declinists thought they were looking at." 

In the realm of investments, it seems that many people also subscribe to a gloomy view of our future prospects.  It is easy to project that the recent malaise will continue.  But as Adam Gopnik points out:

"Whatever happens next, short term or long, is likely to be more affected by accident and by invention -- and by new ideas -- than by any trend now in sight...Declinism is a bad idea, because no one can have any notion of what will happen next.  Yet the idea of our decline is emotionally magnetic, because life is a long slide down, and the plateau just passed is easier to love than the one coming up."

Beware of predictions. In 1918, the German historian Oswald Spengler declared in the "Decline of the West," that physics was finished as a science since its task of description was complete.  Of course, just around the corner were the great works of Einstein, Bohr, and Planck.  Oh well!


Words of Wisdom

And all this science I don't understand;
It's just my job five days a week.
-- Elton John/Bernie Taupin "Rocket Man"

Governments do no more to create jobs than babies.  In fact, their proper role in both endeavors should be identical -- they maintain conditions under which the generative processes can readily proceed.
-- Michael Aronstein, Marketfield Asset Management

[Editor's Note:  The first quote refers, of course, to the mention of physics.  The second quote seems quite germane to the larger topic, although we do not necessarily fully subscribe to its political/economic posture.]

News & Notes

Fun with Diversification

We learn at an early age not to put all our eggs into one basket (although few of us walk around with a basket of eggs). An obvious application of this saying involves investing. We know that sometimes a particular asset class is in favor, while at other times it can get a bit ugly. So it makes sense to expose yourself to a diversified group of asset classes to insure a smoother ride.

The topic of diversification can lead us to many interesting and complex areas, but let's focus on a simple comparison of large cap U.S. stocks (S&P 500) and several foreign stock indices -- broad-based (MSCI EAFE), general emerging markets (MSCI Em Mkts) and the flavor-of-the-month, Brazil, Russia, India, and China (MSCI BRIC).

We can see in the chart below that foreign stocks have mostly outperformed the S&P 500 if you have been patient. In the first eight months of this year (YTD), however, foreign equities have been a significant drag on your stock returns.

Performance

	YTD	3 Yrs	5 Yrs	10 Yrs	15 Yrs
S&P 500	-1.77	0.54	0.78	2.70	6.13
MSCI EAFE	-6.02	-2.96	-1.48	4.96	4.15
MSCI Em MKts	-11.26	1.04	8.56	19.38	11.33
MSCI BRIC	-8.31	5.36	8.72	16.29	7.96

 

In other words, looking at your August 2011 brokerage statement may cause you to wonder why you're investing in foreign stocks. A longer time perspective provides the answer.

The long-term out-performance of emerging markets and BRICs came with a cost -- increased volatility as measured by standard deviation (see chart below). Think of volatility as a roller-coaster. The larger the standard deviation, the greater the ups and downs. Some people may be willing to give up the potential for higher returns in order to avoid the turbulence.

Standard Deviation

	3 Yrs	5 Yrs	10 Yrs	15 Yrs
S&P 500	22.36	18.78	16.36	16.98
MSCI EAFE	27.62	22.96	19.34	18.31
MSCI Em Mkts	33.47	29.62	25.59	27.11
MSCI BRIC	35.86	33.45	29.38	32.87

 

These historical returns are not destined to repeat themselves. These charts are valuable because they show us that results can vary over different time periods. Since you cannot predict with certainty which investment will be the most successful at any given time, keeping your investments in a variety of baskets still makes sense.

 

Words of Wisdom 

Click: Great reasons to keep all your eggs in one basket

News & Notes

The Economy Doesn't Matter

 

The stock market appears to ebb and flow with the daily news about our fragile economy.  Clearly, the health of our economy greatly affects our lives; yet, counter-intuitively, it has less to do with stock performance than you may think.  "Economic statistics have little if any value in forecasting or modeling stock prices," according to the folks who run the Marketfield mutual fund.

Financial Advisor magazine notes that the recent volatility in the stock market has led some investors to search for economic trends and cycles in an effort to predict how the stock market will perform.  After all, as Morgan Stanley points out, "equities are growth assets, so it seems obvious that equity returns should be linked to GDP [gross domestic product] growth."

Morgan Stanley argues, however, that history shows no correlation between GDP growth and stock performance -- "there is little or no link between returns and economic growth."  The Economist cites a number of academic studies that concur with this proposition. 

Ben Inker, head of asset allocation at the global money management firm Grantham, Mayo, van Otterloo & Co., stated that "investing in those countries with the higher GDP growth rate -- assuming you knew in advance what those growth rates would be -- would have failed over the [last 30 years].  There was a negative relationship between GDP growth and market performance."

Why is this the case?  The Economist suggests one answer may be that investors pile into the stocks of high growth countries, thereby driving up their prices, making subsequent returns disappointing.  In other words, the most important factor for future returns may be the relative value of stocks: Are stocks expensive or are they cheap?  Morgan Stanley posits that stock market valuation may be the best guide to future equity returns over the intermediate term.  Ben Inker claims that "the cheapest five markets outperformed the expensive markets by over three percent a year for 30 years."   

While a growing economy provides great benefits for citizens, the ultimate connection between GDP growth and the stock market is not readily apparent to those who seek easy ways to predict the future.   


Words of Wisdom

The fact that some geniuses were laughed at does not imply that all who are laughed at are geniuses.  They laughed at Columbus, they laughed at Fulton, they laughed at the Wright brothers.  But they also laughed at Bozo the Clown.
-- Carl Sagan

News & Notes

The Pain of Patience

 

One of the most difficult times in investing is when a rational, long-term, diversified portfolio becomes blindsided by the heart-stopping emotions of a steep market decline.  As you watch the stock market drift ever lower, your primal instinct is to flee the apparent danger (although our pre-historic predecessors feared dinosaurs and not the news on CNBC).  Doing nothing is not particularly satisfying. 

Hopefully, you have planned ahead for just such an occasion.  Any money you need in the next year should be in cash, not subject to the vagaries of the stock market.  The rest of your portfolio should be diversified among various asset classes commensurate with your goals and risk tolerance. 

If this is the case, then you should not need to touch the equity portion of your portfolio for several years, at a minimum.  This means you can ride it out, however distasteful that may be.  Trying to time the market can often lead to losses by selling low and buying high.

If you are still fixated on the here-and-now, the following points (often contradictory) have been made by "the experts" in numerous conference calls and written commentaries as of late:

• A lot of really ugly stuff is going on in the financial world, including excessive debt in the U.S. and Europe.  Numerous, serious problems need to be worked through.
• The world economy is still growing, albeit at a slower pace.
• While subject to change, corporate profits have been very impressive and their balance sheets are healthy.
• Based on a number of commonly accepted criteria, it can be argued that stocks are relatively cheap.
• Hang in there.

Hopefully you have created your investment plan in a time of equanimity.  Try not to let fear drive your decisions.

Words of Wisdom

One woman who I was dating called and said, "come over, there's nobody home."  I went over.  Nobody was home.  -- Rodney Dangerfield (because we need him in these times)

News & Notes

Perspective

 

After an ugly day in the stock market Thursday, a little perspective may be in order.  On March 9, 2009, the Dow Jones Industrial Average (DJIA) closed at 6,548.  Capitalism as we know it seemed to be in utter collapse.  And yet, less than two years later, the DJIA closed out 2010 at 11,578.  Not many people would have made the bet in March 2009 that the DJIA would have recovered so rapidly.

 

The DJIA closed at 11,384 Thursday.  This constitutes a big drop from its recent highs a couple of months ago.  But it is only about 200 points (or 1.7%) below where it began the year.  The large market swings that we have recently endured exacerbate our sense of fear.  They have not led, however, to significant losses year-to date.  (The broader-based S&P 500 Index is down 3.5% for the year.)

 

It is not clear whether the turbulence will continue.  Stocks may go down further or they may rebound quickly.  Stocks may continue in a yo-yo pattern.  Stocks may even drift around aimlessly for a while.  Whatever may occur, it is important to note that looking at short-term price swings -- especially troublesome declines -- does not provide the full story.


Words of Wisdom 

How many times does the end of the world as we know it need to arrive before we realize that it's not the end of the world as we know it.  -- Michael Lewis (author)

News & Notes

The Debt Ceiling Debacle:

A Manufactured Crisis

 

In The New Yorker this week, James Surowiecki makes a cogent argument that any problems that may arise from the failure of Congress to raise the debt ceiling limit would be a self-inflicted wound.

Surowiecki maintains that the debt ceiling is superfluous because "if Congress really wants to hold down government debt, it already has a way to do so that doesn't risk economic chaos – namely, the annual budget process. The only reason we need to lift the debt ceiling, after all, is to pay for spending that Congress has already authorized."  

Failure to raise the debt ceiling would lead to "an absurd scenario in which Congress will have ordered the President to execute two laws that are flatly at odds with each other. If he obeys the debt ceiling, he cannot spend the money that Congress told him to spend, which is why most government functions will shut down. Yet if he spends the money as Congress has authorized him to he'll end up violating the debt ceiling."

Thus, Surowiecki asserts, we don't need a debt ceiling limit. The concept is an anachronism. It was enacted in 1917 to keep the President in check at a time when he had a much greater ability to borrow and spend money without Congressional oversight. But things have changed. Since 1974 "Congress now passes comprehensive budget resolutions that detail exactly how the government will tax and spend, and the Treasury Department borrows only the money that Congress allows it to."

It seems like we're witnessing a bizarre and depressing circus that needn't be happening in the first place.
 

Words of Wisdom

Weaseling out of things is good. It's what separates us from the other animals ... except the weasel. -- Homer Simpson