Friday, October 31, 2008

Stewart: What If We Were In A Great Depression?

James Stewart of the Wall Street Journal and Smartmoney writes an interesting article that posits how the outlook for stocks would be if we were actually in another Great Depression - in other words, at this point during the beginning of the Great Depression how would have asset classes performed going forward. Stewart answers this and the results are quite stunning.

I'd have to say at this point that we aren't in a Great Depression and aren't even close to one. At least part of that feeling is anecdotal, the malls are packed every time I go there.

The linked article is very interesting and hopefully provides additional perspective.

Scott Dauenhauer CFP, MSFP, AIF

Finally, October Is Over

Halloween is upon us, though it seems we got the trick or treat themes early this year and it certainly wasn't a treat. This October has been the worst on record since 1987 and before this weeks rally was on track to be the worst since 1931. My hope and that of most people is that we can put October behind us and move forward.

There are still fundamental issues that we need to deal with in this economy, but hopefully those issues are now reflected in the current market (and perhaps overblown).

On the bright side, GDP was barely down for the third quarter, coming in at -.3%, better than expected and if gas prices stay where they are or go lower (yes oil is down over 50% in price) we may not even see negative growth for the 4th quarter. Given the devastation and the freeze up in credit, I think the safe bet is that we will have a negative GDP in the 4th quarter - but the average American will have more money in their pocket and more to spend at precisely the time they need it - the holidays (due to falling gas prices).

Things won't be easy going forward and nobody has dealt with the fundamental issues that are causing much of the problems (housing), but I still believe the long term will reward patient stock investors and now presents a good buying opportunity. Certainly for those people who are accumulating for a retirement that is 10, 20 or 30 years away, this is the best thing that could happen to you. This market has taught a lot of people a lot of lessons about risk and diversification.

Thinks aren't rosy, but they may not be as bad as predicted either - remember, the economist are almost always wrong, how many of these geniuses predicted what happened this year in stocks? Very few.

Scott Dauenhauer CFP, MSFP, AIF

Wednesday, October 22, 2008

Life Preserver for Homeowners Under Water

Finally someone outlines the real problem in housing (besides myself)...of course the problem does not easily find a solution. I don't have a silver bullet, but I think there needs to be a combination of government, homeowner and banking industry help. A program where the government provides an incentive for banks to write down the loans, but not a complete bailout. Homeowners (myself included - down 40%) need to share in the pain. I bought a house and it has gone down in value, I could easily walk away - but I won't, the problem is others will. We need to give them an incentive to stay - this has to be a combination of payment relief, mortgage write-down and perhaps some government assistance with the write-down.

Lets say that someone has a $500,000 loan on a home now worth $250,000 - they can make the payments and are not struggling, but they have a huge loss that they don't see a way out of, they walk. If instead of owing $500,000 on this property they owed $325,000 - still under water - but not nearly as bad (and a good possibility of being above water within 5 years - versus 15) and the bank agreed to share the $175,000 loss with the government, say 70% the bank, 30% the government. I don't know, just thinking off the top of my head here - but the banks never should have lent this money to most of the people - the fact that they did led to many people paying inflated prices (which was the banks doing). Stupid should hurt and the banks NEED to feel some pain when they do stupid things. I really don't like the government involvement part, perhaps there is a better answer - or maybe an equity kicker for taxpayers if things recover quickly.

My point is not to present a comprehensive plan, Lord knows I've got more important things to tend too - like my family and my clients. However, smart people should be able to come together and address this problem - until they do.....the recovery will be slow and painful.

Scott Dauenhauer CFP, MSFP, AIF

WSJ: Bernanke Is Fighting the Last War

This interview with Anna Schwartz is perhaps the most important interview you will read. Anna worked with Milton Friedman on a well respected book and is in the same mold as Friedman. She doesn't appear to be happy with the way Bernanke is handling this crisis - she believes that things are different now than during the great depression and thus different things need to be done, Bernanke (a huge student of the Great Depression) is fighting today's problems with the solutions to yesterdays problems.

This is actually a little scary, but I know Ben reads the Wall Street Journal and has a deep respect for Anna....perhaps this is her way of letting him know he needs to make a few adjustments.

This is a fascinating interview.

Scott Dauenhauer CFP, MSFP, AIF

A Conversation With Robert Arnott

I don't agree with everything Arnott says and I'm not a perma-bear, but I think the following paragraph from this article was very interesting and quite telling about how different this stock market downturn has been versus others:

"The nature of this crash has been so sweeping. In September, 15 of the 16 asset classes we track were down. That hasn't happened over the past 30 years. In October it has gotten worse. Most people look at this and feel devastated. The more sensible approach is to look at it as a buying opportunity."

I also read that something like 91% of all mutual funds were down for the year.

Scott Dauenhauer CFP, MSFP, AIF

Friday, October 17, 2008

Buffet, NYTimes: Buy America, I Am

"THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So ... I’ve been buying American stocks."

There is a lot more to this Warren Buffet Op-Ed, if he's buying.........

Scott Dauenhauer CFP, MSFP, AIF

Third Quarter Commentary

Winston Churchill once said "Democracy is the worst form of Government ever attempted in the world. The only exceptions to this are all the other ones tried." Nick Murray once said something similar (paraphrased) "Buy and Hold is the worst form of investing ever attempted in the world. The only exception to this are all the other ones tried"

Some have questioned the wisdom of holding stocks when they are going down and that is understandable, why would we want to continue to subject ourselves to this form of punishment? The answer is that there isn't a better way to capture the long term superior return of stocks, except by holding them during the good and bad times. Keep in mind that the allocation to stocks should be within an acceptable range of risk for your goals. I've always told my clients about the 2000 - 2002 period when stocks dropped by 49% from their high (and the NASDAQ 80%) and that you should expect a 20% drop in stocks about once every five years and a 10% drop every two years. So when the market drops by over 40% twice in an eight year period, that seems to me to be excessive and a difficult way to earn money. While I agree its a difficult way to earn money, there hasn't appeared on the horizon a better way and don't expect one to come along.

Sure there will always be the people out there who tout their market timing strategies that supposedly get you out before the market drops and in before it goes up, but that's not really investing and it doesn't work over long periods of time. You may not lose as much during downturns, but you certainly won't make as much during the inevitable upturns.

Warren Buffet talked about market timing as one of those things that hurt your performance in his 2004 annual shareholder report:

"Over the 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback Corporate America in a diversified, low-expense way. An index fund that they never touched would have done the job.

Instead many investors have had experiences ranging from mediocre to disastrous. There have been three primary causes: first, high costs, usually because investors traded excessively or spent far too much on investment management; second, portfolio decisions based on tips and fads rather than on thoughtful, quantified evaluation of businesses; and third, a start-and-stop approach to the market marked by untimely entries (after an advance has been long underway and exits (after periods of stagnation or decline). Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful."

He wrote just today (October 17th in the New York Times) the following:

"Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over."

If the greatest investor (who in January was Bullish on the American economy) in the history of the world can't predict short term movements, what makes you think your neighbor or some investment guy down the street can?

The hardest thing to do right now is the wisest thing to do, buy stocks. Warren also said in his New York Times piece "A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now."

If Warren Buffet is buying, perhaps our fear, while real, is a bit misplaced.

The key to a good portfolio is to set your asset allocation to a level where you are comfortable with the inevitable short term downward fluctuations (comfortable being a word that is relative). Most people aren't comfortable losing money at all, however the total return available to them after taxes and inflation will be about 2% if they're lucky if they take no risk (and right now if you buy treasuries you are guaranteed a negative return after taxes and inflation). Stocks should be expected to return two to three times that and provide a good hedge against inflation long term. Your biggest enemy in retirement is not stock fluctuation, but inflation. The slow killing off of your purchasing power in retirement will turn that golden nest egg to copper in the span of just a few decades.

These are tough times, there is no doubt about it, but America has faced such times before and come out of them better and stronger than before. A few months ago most people were fretting about the possibility of $200 oil is at less than $70 per barrel, a 50% decline. Things change and prices cycle, that is the nature of free markets (ok, somewhat free markets). We still have fundamental problems in our economy that no one is addressing (Social Security, Medicare, Medicaid, Energy) and things aren't perfect, but things will never be perfect.

Buy and Hold may be the worst form of investing ever attempted, but is much better than all others ever tried.

Hang in there, this too shall pass.

As always, I'm available to talk.

Scott Dauenhauer CFP, MSFP, AIF

Suze Orman: Hall of Idiots?

I've elected Jim Cramer and Richard Kiyosaki into the Hall of Idiots over the past few years primarily because they promote behavior and give advice that is either foolish or self-serving. The Wall Street Journal did an article today about Suze Orman and how this financial panic is making her more of a star than ever. I can't stand watching or listening to Suze Orman, it drives me up the wall and batty. I think the most annoying sound in the world is Suze Orman saying "girlfriend". The article featured a couple people complaining about Suze, mainly advisors who said she was a fear monger (to be fair, a few things she has said I think could be considered just that) and profited unduly from her celebrity by doing endorsement deals.

I think this is all just professional jealousy. Lord knows Suze bugs me, but she is no idiot. Her books are great and have helped a lot of people. There generally gives good advice and her books are probably the best way a financial neophyte (even Men, not just Woman) should begin to learn about personal finances.

I won't be watching Suze or listening to her on the radio........but I also won't be adding her to my Hall of Idiots, she doesn't deserve that, she's done to much good.

Scott Dauenhauer CFP, MSFP, AIF

Thursday, October 16, 2008

What Happened to $200 Oil?

On June 16th I posted a story, "Expensive Oil's Days Are Numbered". Today only dropped under $70 per barrel, a more than 50% decline. Now if we would only see lower prices at the pump. If I recall correctly I paid at least $4.50 at one point, which means I should be paying around $2.25 pretty soon......prices yesterday were about $3.30, still have a ways to go.

I'm not saying oil won't go back up, it could, especially if we have a weak dollar. I just think that its important to point out that almost all experts where wrong.

Scott Dauenhauer CFP, MSFP, AIF

FDIC ChairWoman and Me....How To Put An End To This Mess.

I think I've found my hero, Sheila Bair, the FDIC Chairwoman. In an interview with the Wall Street Journal she said:

"Why there's been such a political focus on making sure we're not unduly helping borrowers but then we're providing all this massive assistance at the institutional level, I don't understand it," she said. "It's been a frustration for me."

The fatal flaw in the plan's being pushed by the Treasury and the Federal Reserve is that none of the plans address the underlying issue - housing prices and foreclosures.

This is not to say the government isn't doing a lot, they are - which is different (despite what is being misreported) than during the Great Depression. The government became hands off and protectionist during the Depression and held onto the Gold Standard for too long. Things didn't start improving until the government stepped into help - its not that things wouldn't have naturally improved, they would have, but it could have taken even longer.

This time the government (and world governments) have taken measures to help prevent what happened in during the Great Depression, so far they have been unsuccessful, but I suspect that many of the measures are simply a matter of time.

Of course the one thing nobody has addressed directly is housing and foreclosures. Congress did pass a $300 billion "Hope for Homeowners" package earlier this year, but that was a smokescreen to make you THINK they were doing something about the little guy when in reality they were passing legislation to bail themselves out of the Fannie and Freddie mess (the bill was modified to allow for the conservatorship of the two mortgage giants). The Hope for Homeowners program is in a word...non-existent. The program was meant to encourage lenders to lower the loan amount to 90% of the current home value and then refinance the loan off the books into the FHA - because it required such a massive write down, there has been very few if any takers for this program. In fact, it is nearly impossible to get a lender to even talk about the program, IF they even know about it. Heck, I called Freddie Mac the other day and an employee of 20 years didn't know he was now a government employee!

John McCain has actually taken a very good stab at this underlying problem, yet has gotten zero credit for it....most likely because his proposal is a complete giveaway. He proposes to refinance underwater homeowners out of their loans - basically buying the loans at full price from the institution who owns the loan. The problem with this proposal is it is TOO MUCH government money being spent. You may think me crazy to say that considering the $700 billion "rescue" package that congress passed (at a treasonous cost of $150 billion in extras), however there is a high probability that the entire $700 billion will come back plus more, so in reality it isn't really a giveaway, its an investment that should (that's a big should) bring more into the treasury than is expended.

Its easier to propose a $700 billion dollar program that will make the Treasury (and thus the American people) money than it is to propose a $300 billion program that is a direct giveaway to banks and taxpayers. Readjusting the mortgages by reducing principal is a good idea and will help to stem the current crisis and get housing back to stability, but it shouldn't be done as a complete giveaway.

For those of you who are wondering just why the heck I would propose rewarding those who got themselves in over their head you must remember that you are being affected by this crisis precisely because of these people's situation and THEY now hold the power over all of us. What do I mean? Let me give you a personal example, myself:

Four years ago my wife and I decided that it was just too expensive to buy the home we wanted in Orange County. We wanted to have more children and I wanted her to stop working (for at least a few years), the problem was that I felt the housing market was overpriced, in fact, I was featured in a June 14, 2004 Bloomberg article by John Wasik titled "Is U.S. Housing Boom Coming To An End?". The opening to the article is as follows:

"Is the long, ascending march in U.S. home prices reaching a summit?

Scott Dauenhauer, a fee-only financial planner in Laguna Hills, California, for one, isn't sanguine about home prices in Southern California, where double-digit increases are common.

Having sold his 1,000-square-foot, two-bedroom home six months ago for $350,000 -- he paid $170,000 in 2000 -- Dauenhauer says he's not really timing the market, yet found home prices in his area ``ridiculous.'' He's looking for a three-bedroom home with a yard for his wife and three-year-old son in Orange County. For now, he's renting while prices continue to soar.

As rising mortgage rates chasten the housing boom, it's time to consider whether you should buy new property or borrow against your home based on the presumption that home prices will ascend endlessly.

``A friend who lives about mile away who has a four-bedroom, 2,500-square-foot home said a home similar to his just sold for over $900,000,'' Dauenhauer said. ``I think there's a bubble. It's similar to the Nasdaq (stock market) several years ago. I tell any clients who come to me who want to buy a house that there's more downside than upside now to the home market.''

To buy the home we wanted in Orange County would end up costing up at least $1.2 million (this was 2004), this is an interest-only payment of $6,250 per month, add in taxes and HOA dues and the monthly cost rises to about $7,800. I pride myself on living within my means and being able to offer a great financial planning service at a reasonable cost, it was clear what I had to do - either double my fees to my clients (which I wouldn't do) or move out of Orange County and buy where I could afford.

We decided to move to Murrieta, CA - a town an hour east of Orange County. We were able to buy a brand new home just like the one we wanted in Orange County for $470,000, that is a 60% savings. We saw the bubble coming and did what we thought was best, buy what we could afford. The problem is that Riverside county (where Murrieta is located) got hit hard by the bubble, much harder than I would have ever expected. Murrieta's rapid growth came from people who worked in Orange, Los Angeles, and San Diego Counties - they commuted (sometimes the husband and wife). When gas prices nearly tripled to close to $5 per gallon, it was too much to take - they were spending upwards of $1,000 or more per month on gas and living in a home that had fallen dramatically in value.......many left. This caused an even further decline in housing prices. I had my home appraised in February 2007 at $555,000. I knew this was a sham appraisal, there was no way it was worth that - I saw this happening everywhere (I called them pick-a-price appraisals). My house is now worth probably $270,000 (though I doubt I could sell it for more than $250,000). There were a lot of people buying houses that never should have been in the market in the first place and this artificially inflated prices, when those people left the market......the merry-go-round stopped and prices fell dramatically - in my case 55% from its high.

Unlike many of the homeowners, I've got a great deal on my mortgage. I've always believed in being conservative when it came to a mortgage - thus I got myself a 30 year loan with a 5.875% interest rate. The payments are affordable and there are no adjustments to come. The problem though is my house is worth a heck of a lot less than what I owe. The power has shifted dramatically to me - if I walk, the owner of my loan is going to have major problems. The second trust deed would be completely wiped out and the first trust deed would have a foreclosed home that will sit on the market for 6 - 12 months or longer with no income and will probably sell for $250,000 if they're lucky. This is a minimum 40% loss for the first trust deed holder. I've got every incentive to walk away and if I suffer. By the way, I'm not walking away - but there are a lot who would.

You suffer because the downward spiral will continue in housing, we'll see more houses on the markets due to foreclosures, less buyers because the banks will continue to NOT loan money as their balance sheets deteriorate even further (and need even more government infusions) and the mortgage backed securities will be worth even less....which creates even further problems. Just as in the great depression, the banks have stopped lending (71% of home lending during the great depression was government). They won't start lending again until they see safety. Washington Mutual has a huge amount of Option Arm loans coming due in the next 24 months and this will put further pressure on homeowners to walk away. The more that walk away the further the decline goes and the more everyone suffers - Trillions have been lost because Billions were walked away from. One other you think I'm going to put a dime into my house while its worth about half what I paid? Not a chance, my wife wants hardwood floors and crown moulding.......there is no way I'm putting money into this thing.......and I can tell you that my neighbors feel the same way, this further hurts the economy.

My main point is the FDIC Chairwoman is right, we need to give an incentive to homeowners who can afford to stay in their homes to actually stay in the homes and not walk away. As much as I hate government intervention, desperate times call for desperate measures and a program that combines government incentives, direct infusions, government guaranteed loans and a loss sharing provision with the banks and owners of the loans is what is needed. Banks shouldn't be made whole by the government, however if they have to take too much of a loss they simply won't take it.

I'm not saying all of this as an effort to get a government bailout, if it helped I'd forgo principal reductions if it meant others could get them. My clients stock portfolio's are hurting right now and the underlying causes are not being addressed - that is my main concern.

It is time we moved past this housing/credit/financial crisis and the way to do it is to address the underlying problem - housing.

Scott Dauenhauer, CFP, MSFP, AIF

Friday, October 10, 2008

Warren Buffet Interview

Warren Buffet had a conversation with Charlie Rose about the economy and the current financial crisis, what follows is an excerpt from that conversation that I think you may find interesting. This is a small excerpt from an incredible interview with Buffet and I think you should read it. It's long and if you'd rather watch it the video link is below. He speaks in plain language and is well balanced. Its not all roses (not pun intended), but it is real straight talk.

"Oh, I think confidence will come back. I will tell you this. This country is going -- be living better ten years from now than it is now. It will be living better in 20 years from now than ten years from now. The ingredients that made this country, you know, the miracle of the world -- I mean we had a seven for one improvement in the average American standard of living in the 20th century. Now, we had the great depression, we had two world wars, we had the flu epidemic. You know, we had oil shock. You know, we had all these terrible things happen. But something about the American system unleashed more and of a potential to human beings over that hundred years so that we had a seven for one improvement in -- there's never been any -- I mean, you have centuries where if you've got a 1 percent improvement, then it's something. So we've got a great system. And we've got more productive capacity now than we ever have. The American worker is more productive than he's ever been. We've got more people to do it. We've got all the ingredients for a sensational future. It's just that right now the athlete's on the floor. But we -- this is a super athlete."

Link to Video

Scott Dauenhauer CFP, MSFP, AIF

Monday, October 06, 2008

Is This a Replay of 1929?

In short, no. Paul Samuelson gives us a good look at the history of recession and depression. He outlines the big differences between now and 1929. This is a short article, worth your time reading today.

Scott Dauenhauer CFP, MSFP, AIF

Friday, October 03, 2008

What is Mark-to-Market and Did It Cause A Panic?

Lately you've been hearing a lot about an esoteric accounting rule called "Mark-to-Market" (here in out referred to as M2M). Your eyes probably glaze over, but this accounting rule is partially to blame for the recent panic. Don't get me wrong, the underlying problems of this financial crisis are loans made to people who couldn't afford to pay them back (as well as credit agencies and appraisers), but the actual panic and seizure of the credit markets may be due more to M2M than anything.

What exactly is M2M? Its actually a reasonable method of valuing assets during normal times - it requires a company to value their assets at current prices on their books. Sounds reasonable. The problem is that it goes further than that, it has an effect on the capital structure of a company and recently has caused several companies to become insolvent......on paper.

Let me give you an example (I'm adopting this from Brian Wesbury):

You own a home worth $300,000 and you have a $250,000 loan in which you are making payments. Under Mark-to-Market rules if the value of that home drops to say $230,000 the bank will call you up and say "the value of your home has dropped, you need to pay us $20,000 (the difference between the loan value and home value) or we're going to kick you out". Needless to say most Americans would end up losing their homes and exacerbating the problem. Most Americans can't just come up with $20,000. Most Americans however can continue to make payments on that loan (about 95% are right now current). Yes, their is more risk and if liquidated right now a loss would occur - but you don't need to liquidate your home right now, you can wait years to do so and with a high probability the home will be worth more than the loan.

The M2M accounting rules work to require institutions to come up with money for no other reason than because a security is suddenly valued lower, sometimes for no good reason. A security that the institution may in fact hold until maturity and have a reasonable expectation of receiving most of the money back.

This insolvency test put Fannie and Freddie into government hands and each was given a line of credit of up to $100 billion.......of which they've used none of it - they both have positive cash flow. Of course, both entities were destined to fail, but that's another story.

I'm not making the arguement that we shouldn't use Mark-to-Market to help us understand liquidation values - but when its use causes a potential time bomb and leads to makes very little sense.

Most of the panic of these past few weeks has been caused by Mark-to-Market rules, the other to the Lehman failure (which may not have failed if these rules had been eased). The Lehman failure led to a money market fund "breaking the buck" which caused even more fear and panic and let to a complete seizing up of the credit markets.

Today's passage of the bailout bill and the SEC's easing of the mark-to-market rules will hopefully create an environment where we can work on the true underlying problems we face.

Scott Dauenhauer CFP, MSFP, AIF