Wall Street Scandals
Wall Street Scandals have their own orbit don’t they? 2008 saw Lehman Brothers and Bear Stearns collapse in a heap of their own failed (and, with the benefit of hindsight, incredibly reckless) bets on exotic mortgage-related derivatives. 2004 revealed Edward Jones failing to disclose tens of millions of dollars from bedfellow American Funds in undisclosed revenue sharing. In 2000, we had Merrill Lynch analyst Henry Blodget writing that certain investment opportunities were “garbage” and worse in his internal memos, and writing glowing recommendations to the investors to whom the company’s brokers were selling these IPOs and other investments.
An article on the Scientific American website explains the Wall Street scandal machine, saying that skewed (it calls them “assymetrical”) bonus systems is the root of the problem. The way brokerage firms compensate their traders, it is actually smart to be reckless on Wall Street.
To see how this works, consider a trader who is making daily, sometimes hourly bets on… it could be anything, and often is. At the end of the year, the trader is paid a bonus which is usually a percentage of the trader’s profit–many times between 10% and 15%. The trader takes enormous risks. If he guess right, and makes $10 million, he takes home a $1 million to $1.5 million bonus, on top of the $200,000 base. He does this for three years, and then, suddenly, his guess turns out to be wrong and he costs the company a lot of money.
The result? By taking huge risks, and costing the Wall Street firm far more than he generated in revenues, the trader takes home between $3 million and $4.5 million in bonus income. He may be fired, but the article says that traders who lost big are often hired by other firms. One could not be allowed to lose $1 billion, it says, unless one was really important.
The author cites a trader who bet his bank’s money, and received 15% of the profits. In 2005, he bought obscure and high-yielding corporate bonds, which generated profits of $40 million. The trader’s share: $6 million. In 2006, he made $80 million and took home $12 million. In 2007, the markets turned, and his trades lost the firm close to $300 million. The trader was let go, retired comfortably, and the shareholders footed the bill for the enormous losses.
Multiply that by thousands of traders moving money around for a company’s own accounts, and you have one of the most efficient scandal machines ever devised.
Perhaps the worst scandal of all not only still persists today, but also continues to thrive (you can thank the Wall Street lobby machine). The broker-dealer advisory model pushed on Main Street under the guise of the “Suitability Standard” is where financial advisors provide advice and assistance to customers in return for commissions, fees, and other payments as a result of selling their inventory. Irrefutable academic research in behavioral ethics has made it clear that this is flawed.
The Motley Fool has a well researched article “Can Your Edward Jones Financial Advisor Really Serve Your Best Interest? The components of their compensation structure is a telling eye opener: Commissions for fund loads; 12b-1 Fees; New Account Bonuses; Branch Bonus and Travel Awards Programs to name a few. Burton Malkiel, author of the investing classic A Random Walk Down Wall Street, told Bloomberg that “in no event should you ever buy a load fund. There’s no point in paying for something if you can get it for free.” This is a point that John Bogle, founder of Vanguard and a leading proponent of index funds, has made as well throughout his long career.
In 2011, Edward Jones had $4.6 billion in revenue and $1.7 billion of that came from commissions. When Dodd-Frank legislation was being crafted in 2010, Edward Jones circulated a document called “The Fiduciary Dilemna” warning that a fiduciary standard would lead to “unintended consequences” that would severely limit or prohibit the broker-dealer from providing the most appropriate investments to the client. Unfortunately, your legislators blinked and billions continued to be made on the backs of Main Street.
Do you still wonder where scandals come from?
Sources:
http://edition.cnn.com/2011/BUSINESS/09/15/unauthorized.trades/index.html
http://dealbook.nytimes.com/2012/05/10/jpmorgan-discloses-significant-losses-in-trading-group/
http://www.huffingtonpost.com/2012/11/20/kweku-adoboli-ubs-rogue-trader-convicted_n_2163897.html
The Beat Goes On
Stop watching reality television. Especially themes around fiscal cliffs. The train has left the station and the U.S taxpayers never heard the whistle. The vast majority are still being conned by the elaborate Wrestle-mania in Washington between Hulk Hogan and Macho Man Randy Savage. (My apologies to those who still believe its real.) So let’s stop watching reality t.v. start planning for the new paradigm: Euro-merica.
The Fed and other central banks around the world have doubled their balance sheets in failed attempts for higher economic growth. Brian Westbury, Chief Economist at First Trust, sums this up brilliantly: “Like we have been saying for many months, quantitative easing will simply keep adding to the already enormous excess reserves in the bank system, not deal with the underlying causes of economic weakness, including the growth in government spending, excessive regulation, and expectations of higher future tax rates. It will not add anything to economic growth and, as long as banks are reluctant to lend aggressively, not cause hyperinflation either.”
The evidence about tax rates and revenues is irrefutable. Milton Friedman proved that all government spending is taxation and does not stimulate the economy. After all, shouldn’t Greece have spent their way to prosperity? Economic truths don’t matter when the mandate is to increase the size and scope of Government. Yet, the mandate is couched with class envy using the sales pitch “tax those who can afford to pay a little more”. Herbert Hoover proved this not only doesn’t work, but also makes matters worse. If you worked more in order to make more money and invest your earnings increased your taxes, you probably won’t work harder. Most of people and companies will choose not to. That’s the effect of confiscatory taxation will have on the economy as a whole.
Reading the Tea Leaves
So the squeeze is on. Increasing taxes, regulations and govt spending will hamper economic recovery and handicap real growth in US Equity Real Estate prices.
The continued printing of dollars may give stocks and real estate some upside because all this money has to go somewhere. The Fed will continue to print money, and the result will be inflationary with a weaker dollar and stronger non-dollar asset prices.
I don’t see a long-term bull market based on sound economic policy: However; owning equities, real estate and commodities do offer opportunities for growth as well as an inflation hedge. Scott Grannis has posted an excellent article on his blog about “Equities as an inflation hedge” here: http://scottgrannis.blogspot.com/2012/12/equities-as-inflation-hedge.html
US Treasury bonds have traditionally been the asset class to own in conservative portfolios because of their safety and stability. That has changed. Treasury bonds are very expensive (i.e. they pay very little interest) and when interest rates move up, these bonds will drop considerably. I’ve been reducing exposure to these bonds and continue to do so. Inflation will be the pin that pops this balloon.
I may be going out on a limb, but corporate bonds, especially high yield bonds may prove to be less risky when interest rates rise. Also, municipal bonds are still a good investment due to the increase in Fed and State tax rates, as long as you stay out of the junk states like California and Illinois.
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Fascinating Story that Illustrates the Paradigm Shift in Education
Sebastian Thrun started an on-line class called “Introduction to Artificial Intelligence” while teaching at Stanford. He used the on-line format because enrollment in the physical class at Stanford was only 200 students. 160,000 people signed up for the class from around the world. 23,000 people finished his course. The top 410 exam scores came from on-line students. The first Stanford student came in at No. 411. He resigned his tenure at Stanford and started www.udacity.com
From Andy Kessler’s article: http://www.andykessler.com/andy_kessler/2012/06/wsj-weekend-interview-sebastian-thrun-whats-next-for-silicon-valley.html#more
Forbes also has an article on Salman Khan, the 36-year-old founder of Khan Academy. With 10 million students, Khan Academy is the largest school in the world. The site is used by 6 million uniques students each month who have collectively solved more than 2 million problems per day. Interesting statistic: The US spends $1.3 trillion a year on education yet ranks 25th out of the 34 OECD countries in math, 17th in science and 14th in reading. Read more here: http://www.forbes.com/sites/michaelnoer/2012/11/02/one-man-one-computer-10-million-students-how-khan-academy-is-reinventing-education/2/
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The Quest for The Best Chili Recipe
I love chili and I’ve tried over a dozen recipes. I may have hit gold with the Cooks Illustrated version. Normally, you have to subscribe to get his recipes but I found it on epicurious. http://m.epicurious.com/recipes/member/views/COOKS-ILLUSTRATED-ULTIMATE-CHILI-50092399 You make the chili powder from scratch using dried ancho and arbol chilies. I only found them at Piggly Wiggly.
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“Common Sleep Mistakes Can Wreak Havoc on Your Health, and Increase Risk of Migraines and Dementia” by Dr. Mercola.
Having gone the route of failed CPAP therapy, and three surgical procedures, I can tell you that poor sleep wreaks havoc on you. Two minutes reading this article may change your life.
http://articles.mercola.com/sites/articles/archive/2012/11/26/common-sleep-mistakes.aspx
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My Boys Hide When I get out My Scissors
For some reason, I like cutting my two boy’s hair. Santa even gave me a pair of real barber scissors this Christmas! If your curious and you sufficiently bribe your kid, check out this website tutorial and give it a try. http://www.howtocutchildrenshair.com/what_you_will_need.html
A note of caution: Your first few attempts should NOT be during normal operating hours of your regular barber or hair stylist.
August Potty Reading
I’m starting this edition of Potty Reading with something inspirational before I subject you to the torment of my soap box.
Many of my clients and friends have heard me say before that even if I won the lottery, I would still do what I do. I love the puzzles and challenges that comprehensive planning demands of me, but more than that I think, I love the priviledge of helping, getting to know, and developing friendships with some very special clients. In life, we are fortunate to meet people who make us want to better and stronger in our faith. I’m blessed to know Gary and Terri Lockman and share this video with you.
http://www.youtube.com/watch?v=bErHzSfXj3w
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Depublican and Remocrate Policies Must Stop
Uncertainty is a key theme everywhere we look. The financial mess in Europe, political turmoil at home, and dubious economic policies have all but caused the stock market to capitulate. Treasury bonds and AA corporate bond yields are pushed so low, its as though the bond buyers are waiting for the priest to read the last rights to the stock market.
The turmoil in Europe centers around entitlement, conflicting ideologies and unchecked fiscal policy. Sounds familiar? Yes, and it affords us a glimpse of where we could be in about a dozen years. One of my favorite Gurus, Robert Sanborn, who runs the Elkhorn Fund, eloquently said: “1) we live in a world where the prudent are constantly ridiculed, pressured, and compelled to bail out the imprudent (with predictable “incentive effects”); and 2) politicians throughout the West, particularly on the left, have zero desire to address any long-term structural issues related to the bloated “public worker/entitlement” state.”
Even though we can look to Europe as our future fate, November will be the tipping point for the US. Greece, for example, borrowed an extraordinary amount of money at cheap rates. Hardly any of that borrowed money went into productive long term investments. In fact, the money went to public employees (unions), entitlement programs and to politicians. Deficits kept soaring with no cuts to entitlement, crisis erupts and they make the Germans out to be the bad guys because they demanded balance budgets. As you know, Greece held their election and the socialist won. Ditto France, where the new prime minister just lowered the retirement age to 60 and raised the top income tax rate to 75%. Can you find a startup company to come from France in the last 10 years?
Europe’s economic policy is one of tax and spend, also know as Keynesian. Though flawed, politicians like the power it affords them. Voters quickly learn which Politicians will turn on the red light for them and thus, they start voting themselves the treasury. Now we have red light politicians scoffing at the idea that to have welfare, you must first have wealth.
So here we are, with 65% of the Federal Budget going to entitle someone, or some group, reversing the spread of entitlement cancer will be very difficult. In the last 4 years, Federal jobs have doubled and so has unemployment. Did you know that the average salary with benefits for a federal job is $150k vs $62k for the private sector?
While we certainly have our challenges ahead, we still have the fundamental elements in place to return to a healthy, growing economy: the spirit of the American entrepreneur, fertile agricultural land, and abundant natural resources. Wisconsin and Indiana are now beacons of fiscal reform for other states to follow, while California and others drive off the tax and spend cliff.
With uncertainty comes volatility, and investors fleeing volatility will loose opportunity. One-year CD rates are averaging below 1%. That’s a high price to put savings in a “safe” investment when inflation is 3%. Don’t pay the priest yet. Equities are not dead and the neither is the idea of limited government.
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Speaking of The American Entreprenuer.
We know that technologies can be disruptive. The link below is about Sebastian Thrun who’s disrupting education. Stanford snubbed his idea of providing an online class for Artificial Intelligence. 23,000 students completed his course. Of his 200 Stanford students enrolled, 30 attended lectures and the other 170 took it online. The top 410 performers on exams were online students. The top ranked student from Stanford came in at 411.
http://online.wsj.com/article/SB10001424052702303807404577434891291657730.html
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We The People Can Be Resilient.
Thank you Mrs. Brown for a fascinating article about the human spirit.
Secrets of the Super Resilient
Illness. Divorce. Job loss. The death of a loved one. You don’t get this far in life without experiencing some adversity. But while you can’t avoid painful events, you can learn to control your response to them. “The brain is an organ of adaptation,” writes Laurence Gonzales, author of the new book Surviving Survival: The Art and Science of Resilience. Here, he reveals how recovery can be a transforming experience that not only moves us forward but also enriches our lives in ways we never could have imagined
by Laurence Gonzales http://www.more.com/secrets-of-the-super-resilient
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Your Tax Dollars are Working Hard to Watch YOU.
I have a thing for conspiracy stuff, so I thought I would share this:
“Big Brother is watching. No kidding. And the warning is coming from none other than Google, which says government spies may be spying on you. Some believe the Google announcement may be related to the recent discovery of the data-mining virus named “Flame.” In a June 3 New York Times article, Andrew Kramer and Nicole Perlroth write1:
“When Eugene Kaspersky, the founder of Europe’s largest antivirus company, discovered the Flame virus that is afflicting computers in Iran and the Middle East, he recognized it as a technologically sophisticated virus that only a government could create.
He also recognized that the virus, which he compares to the Stuxnet virus built by programmers employed by the United States and Israel, adds weight to his warnings of the grave dangers posed by governments that manufacture and release viruses on the internet.
One of my favorite commercials
Fed Policy and Your Bonds, DC’s
Government spending and the Fed’s policy of buying more long-term bonds, never mind how they pay for it, has pushed the U.S. Treasury yields to lows not seen since the 1940’s. This is significant because your conservative, “safe” money like T-bills, Treasury Bonds and even your CD’s are now subject to a certain type of risk: Purchasing power erosion, or inflation risk.
Bonds have 3 sources of risk: 1) Credit Risk – The risk of not getting paid back; 2) Duration Risk – the risk that rising interest rates will decrease the value of your bond because other bonds will pay higher yields. 3) Inflation Risk – The risk that the dividends you may get today will not buy as much groceries or gas in the future because of inflation. Along with these risk definitions, I also want to explain two terms used when discussing interest rates: The Nominal Return – the interest rate on the face of the bond or you see advertised on a bank CD for example; and The Real Return – the return you get after subtracting inflation.
Today, bond holders must deal with this purchasing power erosion. The Federal Reserve policies are keeping nominal rates below the rate of inflation. They’ve done this to keep financing costs low on Uncle Sam’s out of control spending. The result of this effectively shifts the burden of government spending onto you. How? Because the nominal 2% nominal return on 10-year Treasury bonds is below the 2.9% rate of inflation. Therefore, the real return on your bonds is -.9% and will continue to erode because it doesn’t keep pace with inflation. Even worse, calculate the real return on your CD.
We can look at the 1940’s as an excellent example of bond investing because it mirrors today’s environment with roughly the same nominal yields on Treasuries and Government spending greater than 100% of our Gross Domestic Product (GDP). If you invested $100,000 in 10-year Treasury bonds in 1941 to and redeemed your bond in 1951, you got your original $100,000 back, but in real return dollars, you lost $34,000 to inflation.
Some ideas for you to consider if you have heavy bond exposure:
First look to diversify within the bond asset class. This means look beyond U.S. Treasuries and AA rated U.S. Companies to foreign bonds, higher yielding corporate bonds. Also, you can diversify outside of bonds all together and research lower volatility stocks.
Second, refresh yourself on the definition of safety. What most people, especially retirees are looking for when investing in bonds is income. While continuing to hold CD’s and Treasuries with low nominal yields may serve one definition of safety, continued erosion of your purchasing power by inflation needs thoughtful consideration. Holding Treasuries and CD’s guarantee the return of your money, the cost of a good night’s sleep does come at a price. Like most things in life, there’s no such thing as a free lunch, unless of course you’re in the Senate or Congress.
January Potty Reading
2011 was full of challenges, including the continual financial crisis in Europe, the Arab Spring in the Middle East, natural disasters and political dissent in the United States. Markets don’t like uncertainty and thus a year of volatility across global financial markets.
As I’ve stated before, our problems revolve around policy, and sadly, I don’t see our current elected leadership making a significant departure from the futile Keynesian policies. Washington is completely inept at tackling our debt, and I believe we will see our debt limit raised again this year. Bureaucrats cannot spend money more efficiently than the people who earn the money, and politicians cannot make better investment decisions than private enterprise. Industrial policy has never worked anywhere, and we see multiple examples of its failure almost every day in the headlines.
Once the Great Melting Pot, the US has created a Great Dependency Pot that is now so entrenched that true reform is politically impossible. Our social welfare is an excellent example of how U.S. policy is driving into the abyss. Social welfare benefits make up 35 percent of wages and salaries this year, up from 21 percent in 2000 and 10 percent in 1960. How about Federal wages? Since Obama took office, the number federal workers that make over $150,000 has more than doubled. On average, federal employees total compensation is TWO FOLD higher than private sector. Good luck reforming social welfare.
What’s in store then? High volatility will remain the norm. 2012 is a pivotal year for global politics and leadership changes in the U.S., China, Europe and others in the developing world. This will create opportunities and risks. The debt bubble will continue to threaten growth. Again, this is a game politicians here and abroad can stop playing and address. Will they? Probably not and that’s why November is so crucial.
I believe people are waking up to the fact that the trillions of dollars of wasteful government spending in the past several years hasn’t worked. There’s more main stream awareness, debate and admissions that government spending not only doesn’t stimulate, it in fact has hurt us by squandering precious resources. I’m hopeful that the presidential elections will focus the country’s attention on failed Keynesian policies and how to get back on track.
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One of my daily readings comes from the Calafia Beach Pundit, Scott Grannis, who was Chief Economist from 1979-2007 at Western Asset Management. Scott is a supply side economist who has an excellent blog.
This helps explain the lack of jobs
“It takes a Hungarian to help us understand why the U.S. economy is not creating enough jobs. Bottom line: taxes are too high, regulations are too onerous, you can’t fire anyone, it’s easy for employees to sue you, the law favors employees over employers, those who skirt the law have the advantage, the press vilifies success, and the tax code punishes success and rewards slackers.
Read this rant, translated decently from Hungarian. HT: John Cochrane, whose recently-started blog is off to a great start.”
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Money Buys Policy…AGAIN
There’s no shortage of ways that lobbyist find to change policies to the detriment of Main Street. A great story in the Washington Post by Barry Ritholtz (http://www.washingtonpost.com/the-systemic-risk-revealed-by-mf-globals-collapse/2011/12/14/gIQAtrTI1O_story.html), who notes that in 2010, Jon Corzine, CEO of the now-infamous MF Global organization, successfully lobbied to prevent the Commodities Futures Trading Commission from imposing regulations against borrowing client assets to buy risky European sovereign debt.
Mr. Ritholtz reports that MF Global also successfully petitioned the CFTC to deregulate the rules covering customer accounts and segregated monies, and let commodity brokers perform “internal repos of customers’ deposits,”–an off-balance sheet maneuver that, among other things, eventually allowed Lehman Brothers to hide $100 billion in debts during the 2008 market meltdown. Before that, in 2004, the five largest U.S. investment banks successfully petitioned the SEC to waive their net capitalization rules. The ironically-named “Bear Stearns exemption” opened the doors to 40-1 leverage.
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This Judge Couldn’t Be Bought
Judge Jed S. Rakoff challenged the SEC’s boilerplate language in its settlement of fraud charges against Citigroup. In case you missed it, the SEC charged that Citigroup had sold tranches of mortgage-based debt–the infamous CDOs from the 2008 Wall Street scandal–without disclosing that it was betting against $500 million of the deal in what internal e-mails were describing as “The best short ever!!”
This once-in-a-lifetime short bet, combined with selling the dog investments the company was shorting, resulted in $160 million in fees and trading profits to Citigroup’s bottom line.
The SEC’s proposed fine: $95 million.
In addition, the SEC settlement required that Citigroup neither confirm nor deny the charges in agreeing to the fine. The judge asked why the fine was so low and (this is the part that had me cheering) wondered whether there isn’t “an overriding public interest in determining whether the SEC’s charges are true.”
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Wow! Maybe I Should Become a Stockbroker!
Some brokerage firms are now offering 330% bonuses to brokers who make the switch from another firm and come to them. This essentially means 330% of the trailing commissions earned by the broker over the past year. This is upfront money and the firm would not be investing in these new brokers if it didn’t expect the money to return to its coffers. John Lame, a former Merrill Lynch broker explains: “If you’re in a corporate finance department, in most cases, you’re requiring a 3-year break-even point on your investment. They expect to get to breakeven at least by the end of year three.”
This, in itself, is kind of astonishing. In other words, the firm projects that it will generate AT LEAST a 100% profit margin, per year, on the investment recommendations that its newly-recruited brokers will make to their unfortunate customers.
I do need a new truck!!
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“The 10 Steps To Make Your Kid A Millionaire”
Forbes Magazine has a great article by William Baldwin. If you have children, this is a must read..
“We’re spending our children’s money. So goes the refrain from people appalled at the government’s deficits. As long as entitlement spending and tax collections continue on their present course, it’s an undeniable truth.
Instead of wringing your hands, do something about it. Make your children so prosperous that they can withstand the Medicare cutbacks and tax increases that lie ahead. Here are ten tactics for boosting the net worth of your offspring.”
Here’s the link: http://www.forbes.com/forbes/2011/0627/money-guide-11-kotlikoff-roth-ira-mutual-fund-kid-millionaire.html
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Is Your Doctor Paid to Promote a Drug?
I found a very interesting website, thanks to Dr. Mercola’s website.
Doctor’s rely heavily on information from their pharmaceutical reps and from other ‘experts,’ i.e. doctors who are receiving significant fees to talk about drug treatments. Pharmaceutical sales reached a staggering $300 BILLION last year, up five percent from 2008. So how much does big pharma spend on marketing to doctors? According to a new database created by ProPublica, seven drug companies paid $282 million to more than 17,000 doctors during 2009-2010.
According to Dr. Mercola, prescription drugs are responsible for an estimated 700,000 ER visits a year due to adverse drug reactions. And adverse drug reactions from drugs that are properly prescribed and properly administered cause about 106,000 deaths per year, making prescription drugs the fourth-leading cause of death in the U.S.”
Check out the Dollars for Docs and see if your doctor is getting paid. http://projects.propublica.org/docdollars/
Your 2012 Financial Planning Checklist
For 2012, I’ve put together a checklist to help you take a deeper look at your financial picture, address a few important areas of financial planning, as well as provide you with some suggestions for the new year.
The Basics
¨ Create a Financial Plan. By setting long term and short term life goals, a financial plan helps you see the big picture. With a strategy in place, your goals are measurable and financial decisions have greater clarity and less stress. If you don’t already have a plan, make one. Check out http://www.letsmakeaplan.org/ for more info.
Estate Planning
¨ Get a Will. If you don’t have a will, the state of Georgia has one for you. A will give you the ability to decide who receives what of your assets rather than the court making the decision.
¨ Review Existing Will. If your will lays out a division of different types of assets among the heirs, you may have some problems because asset values change. For example, if real estate was left to a daughter and stocks left to the son, those values today may have changed considerably. Also consider that the federal basic exclusion amount in 2012 is $5,120,000, and is scheduled to “sunset” (revert to $1mm) on January 1, 2013.
¨ Georgia Advance Directive of Healthcare. Designate a family member or some other person to make medical decisions for you, instead of the court, should you become incapacitated. http://www.aging.dhr.georgia.gov and select “Publications” on the left side for the form.
Insure Your Assets
¨ Your assets are more than just home, auto and life. Do you have replacement cost coverage? If you are still working, your earnings need to be insured with disability coverage.
¨ Can you afford a $74,000 a year bill during retirement? If you answered no, then insure your nest egg by investing in a long-term care policy. 70% of Americans over age 65 will need some level of long term care. For more information, read my previous article titled “Long Term Who Cares?” http://www.rockdalenews.com/archives/1234/
Investments
¨ Read the #1 New York Times Bestseller, “The Investment Answer” by Gordon Murray and Daniel Goldie. This 63 page book will have a direct impact on your long term investment performance by showing you how to become a smarter investor.
¨ Do you have a diversified portfolio? Diversification doesn’t mean having several advisors, brokerage companies or different mutual funds. Real diversification is means investments in many different asset classes such as stocks, bonds, real estate, commodities, international securities and alternative investments.
¨ Know your risk. Markets come with risk. Do you know your risk tolerance profile? Make sure you are getting the most return with the least amount of risk. Ask for a risk/reward profile on your portfolio based on your profile. For example, if you have a conservative risk profile, you shouldn’t have a benchmark based on the S&P 500.
September Potty Reading
LOBBYIST SHAFT US AGAIN
First up, my most recent article for the Rockdale Weekly news titled “Beware Hidden Fees and Lower Standards Until Next Year” is about new 401k regulation to help improve transparency and accountability. Right after my article went to press, the Department of Labor announced their decision to re-propose their ruling on the definition of fiduciary and put in more delays. Classic Washington: Serve the interest of Wall Street at the expense of Main Street. My Article link: http://www.rockdalenews.com/section/72/article/7969/”Beware
From Fiduciary News, I included an excerpt from an article titled “As Brokers Cheer, Advisers Sound Off on DOL 401k Fiduciary Capitulation” by Christopher Carosa.
“Since a fiduciary cannot serve two masters (indeed, a “fiduciary,” with eight centuries of definition behind it, can only serve the beneficiary), it only makes sense that a rule pertaining to the definition of fiduciary serve only one master. Oddly, the DOL’s original proposal allowed brokers to continue receiving transaction-based fees normally prohibited within a fiduciary relationship. The protection of self-dealing transactions stands out as of the primary points extracted from King John by the abused English barony in the signing of the Magna Carta. Sure, it cost the King’s men, but wasn’t that the whole point of the protection?
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DUMB AND DUMBER STILL PLAYING
Federal Government Pays Dead Workers $120 Million A Year: Report
The Huffington Post Jillian Berman
“As politicians debate the best way to address the national deficit, the U.S. Office of Personnel Management has found one line-item that would seem easy to cut: payments to dead federal workers.
The federal government’s Civil Service Retirement and Disability fund has improperly paid dead federal workers $120 million annually over the last five years, a new OPM report finds. One man, whose father died in 1971, continued to receive payments until 2008 when he himself died, costing the government $515,000, according to the report.”
http://www.huffingtonpost.com/2011/09/23/federal-government-retirement_n_977878.html
Borrowing from Communists to pay Jihadist?
Jewish World Review Clifford Day
“The debt crisis, chronic high unemployment, the tumbling stock market, the credit downgrade — these are, fairly obviously, symptoms of an economy in distress. We might disagree about the best policy responses. But perhaps we can agree on the worst: borrow massive amounts of money from the communists who want to diminish us and transfer that wealth to the Jihadist who want to destroy us. Surprise: That long has been U.S. government policy and, so far at least, it remains in place.”
http://www.jewishworldreview.com/0811/may081111.php3
WHY DOESN’T THIS MAKE NETWORK NEWS?
Pretty surprising (and encouraging) poll results from Harris and Zogby. The latest Harris Poll Shows that two Republican candidates could beat Obama: Mitt Romney and Ron Paul. Why didn’t that get more air play? How bout’ the Zogby Poll showing Herman Cain leading the Republican field? And a full 10% ahead of Rick Perry!
Zogby article: http://www.humanevents.com/article.php?id=46473
WE HAVE SOME HOPE FOR PRESIDENTIAL LEADERSHIP
As you know, we need to break the Coke or Pepsi stranglehold politics. I read Tyler Durden’s Zero Hedge every day. Take the time to watch the Jon Stewart interviews of Ron Paul posted here: http://www.zerohedge.com/news/jon-stewarts-extended-interview-ron-paul
INTERESTING HEALTH CLIPPINGS
Could THIS Be the Hidden Factor Behind Obesity, Heart Disease, and Chronic Fatigue?
SAGE STATISTICS
Money Magazine did a very nice piece on “jumping in and out of stocks at the wrong time.” I particularly liked it as the advice is consistent with my beliefs (and good investment theory and reality). Bottom line: attempting to time the market by jumping out when others panic is a loser’s game. A Morningstar study found that over the painful ten years through 2009, the average investors effort to avoid losses cost $15,000 on a $100,000 investment relative to just staying in the market. I was pleased to see we have a lot of professional company. A Money survey of advisors found that 44% ranked “fleeing stocks when the market craters” as the top mistake and right behind that was “flocking to the latest top-performing investments.” The article went on to provide some interesting examples:
- 1966 – Investors flocked to star manager Gerald Tsai’s new Manhattan Fund. By 1974, it had the worst eight year record in the entire industry.
- 1973 – College endowments and other “conservative” (my quotes) investors poured money into growth stocks just before prices imploded 45%.
- 1999 – With the DOW above 10,000, the book DOW 36,000 touted that stocks were still cheap.
- 2006 – As home prices peaked, the National Association of Realtors chief economist published “Why the Real Estate Boom will Not Bust.”
Hens Coming Home
I like using idioms, especially when referring to idiots.
We are coming off a week with market losses of seven and eight percent respectively on the S&P 500 and the NASDAQ. Then Standard and Poor’s downgrades our nations credit rating from AAA to AA+.
Setting the Stage
Our elected officials have had repeated opportunities to serve the best interests of their constituents and have repeatedly betrayed us. In 2008, our elected men and women of honor saddled us with TARP, even though 90% of the voters did not want them to approve it. Do you remember all the lies told to us about how this was going to help get us on track to recovery and promote their marvelous Keynesian beliefs in job growth?
Then we get the failed Quantitative Easing 2 (QE2) administered by a person we didn’t elect. Comrade Bernanke told us in his Washington Post editorial that it would “promote economic growth”. In short, our government has spent over $3 trillion on bailouts to help Wall Street. But where have the politicians been during this wholesale treachery of our trust?
Democrat or Republican, Coke or Pepsi, there is no difference. Have we really become so blinded by corn syrup saturated rhetoric between red or blue that we believe it?
The politicians had an opportunity to right the ship and push for a balanced budget amendment. Instead, they drank their respective hypoglycemic spiked drinks and wet the bed, our bed and our children’s and grandchildren’s.
Imagine your listening to Clark Howard or Dave Ramsey. Someone calls in needing help and advice. The caller has accumulated substantial debt and can no longer make the minimum payments on their credit cards and struggling to keep their mortgage current. The solution offered to the caller is to go get another credit card to help pay the bills. Brilliant strategy right?
The Market Reacts
The result of all this is a flight from risk. What this looks like is exactly what we are seeing and have seen before. When there are more sellers of stock than buyers, the stock prices decline. Moreover, not all stocks are treated equally, as investors see some stocks more risky than others. Naturally this begs the question “what makes one stock more risky than another?”
Stocks with more risk
- A company in the area of discretionary spending. When your dollars become more scarce, are you more likely to buy food staples or high priced cosmetics? Oatmeal or $50 face cream? Even though this is a simplified explanation, I believe it captures the point.
- Companies selling capital equipment. In good economic times, companies will expand their operations by buying new equipment. Conversely, in recessions, companies are reduce or stop capital spending. Most households operate the same way. A new car purchase or home will be put on hold for several years.
- Companies that carry a high debt load is less desirable than a company that has no or little debt and ample cash reserves for operating.
- Companies with negative cash flow carry higher risk than companies with positive cash flow. Negative cash flow drains a companies balance sheet.
- Companies in an industry with many competitors. When sales in the industry declines, everyone becomes more competitive and cuts prices, thus putting more downward pressure on profitability.
- Companies with high valuation multiples. Investors question these companies with high price to earnings (P/E) as to their ability to sustain growth in the economy as well as question the quality of their earnings.
- High beta stocks. Beta is the measure of a stock or mutual fund’s sensitivity to market movements. The beta of the market is 1.00 by definition. If a stock has a beta of 2, then if the market goes up 10%, presumably, the high beta stock would go up 20%. Likewise, if the market goes down 10%, that stock should go down 20%.
While the above characteristics help outline riskier stocks and why some stocks may fall more than others, the larger question you are probably asking is how far the market will fall before we establish a bottom? I wish I had a crystal ball to give you a definitive number. Short of the crystal ball, I can offer my opinion.
I use a term “bloody bottom” to describe when stock prices are trading at or below what a company has in cash on its balance sheet. We’ve seen some of these bottoms in 2002, 2008 and 2009. As of Friday, we are not yet at these levels. Please don’t misunderstand my opinion as a statement of market timing. Market timing does not work. What does work as a long term investment strategy is identifying good companies and buying them at discounted prices.
While nobody can determine where the market is headed in the short term, I’m seeing opportunities starting to arise for accumulating shares of companies and industry groups. The caveat here is the word “short-term” because it will take time, new leadership and economic policies to steer our economy in the right direction. We need wholesale changes in Washington and true supply side economic policies that will attract and keep capital (smart people with their smart companies) in the United States.
401k Alert: Hidden Fees and Lower Standard Continue
A new regulation from the Department of Labor providing much needed fee transparency and accountability for 401k participants was to go into effect on July 16th, 2011, has been delayed until January 2012. The regulation is Section 408(b)(2), and it’s all about fees, potential conflicts, and fiduciary status.
By January 1, 2012, all 401k service providers, including any fiduciaries, record keepers, and brokers must provide written disclosures about their services and costs, fiduciary status, and other issues.
Brokers are scrambling. The industry standard closed architecture system is going to have the light shined under the hood. Bundled services and indirect compensation have allowed hidden fees to go unnoticed for years. Brokers have traditionally received ongoing compensation from the mutual funds on its 401(k) platform without revealing the details of that relationship. Moreover, they most likely have recommended funds that paid higher fees rather than the funds best-suited for plan participants.
Not only will the pending regulations require written disclose about what services they provide to your 401k, but also their hidden, indirect fees they receive, including gifts, awards, trips, research, finder’s fees, soft-dollar payments, fees deducted from investment returns and other kinds of compensation. Previous regulation only required providers to report direct compensation, and they did NOT have to say whether they were a fiduciary.
Identifying who is and who isn’t a fiduciary under the new regulations increases the responsibility and legal exposure for employers. A fiduciary keeps the plan and the participant’s interests ahead of all others. Representatives of an insurance company (such as Principal, ING, John Hancock) or an investment company (Black Rock, Fidelity, American Funds, etc.) are not fiduciaries. “Plan sponsors thought they hired the expertise, but now they will get a document saying, “We’re not ERISA fiduciaries,’ so they’ll wonder why they need that broker around,” said Jason C. Roberts, a partner at the law firm of Reish & Reicher, nationally recognized experts in employee benefits law.
Forbes Blogger Michael Chamberlain makes a great point in his article titled “5 Characteristics of a Great 401(k) Plan: “As background, the 401(k) rules from the DOL and IRS are complex. Employers are busy running their companies and have little expertise running a plan. Employees are poorly prepared to know how much to contribute or how to invest their money. Because of these three facts, the financial services industry, insurance companies and broker dealers have made a killing at the expense of American workers.”
You don’t have to sit on your hands until January. Ask for full written disclosures about your 401k services and costs, and fiduciary status. Hopefully come January, you can compare it to the required itemized statement.
Andrew Brown is a Certified Financial PlannerTM and a Fee-Only Registered Investment Advisor.
Starting July1, all 401k service providers, including any fiduciaries, record keepers, and brokers must provide written disclosures about their services and costs, fiduciary status, and other issues.
The industry standard closed architecture system is going to have the light shined under the hood. Bundled services and indirect compensation have allowed hidden fees to go unnoticed for years. Brokers have traditionally received ongoing compensation from the mutual funds on its 401(k) platform without revealing the details of that relationship. Moreover, they most likely have recommended funds that paid higher fees rather than the funds best-suited for plan participants.
Not only will the pending regulations require written disclose about what services they provide to your 401k, but also their hidden, indirect fees they receive, including gifts, awards, trips, research, finder’s fees, soft-dollar payments, fees deducted from investment returns and other kinds of compensation. Previous regulation only required providers to report direct compensation, and they did NOT have to say whether they were a fiduciary.
Identifying who is and who isn’t a fiduciary under the new regulations increases the responsibility and legal exposure for employers. A fiduciary keeps the plan and the participant’s interests ahead of all others. Representatives of an insurance company (such as Principal, ING, John Hancock) or an investment company (Black Rock, Fidelity, American Funds, etc.) are not fiduciaries. “Plan sponsors thought they hired the expertise, but now they will get a document saying, “We’re not ERISA fiduciaries,’ so they’ll wonder why they need that broker around,” said Jason C. Roberts, a partner at the law firm of Reish & Reicher, nationally recognized experts in employee benefits law.
Forbes Blogger Michael Chamberlain makes a great point in his article titled “5 Characteristics of a Great 401(k) Plan: “As background, the 401(k) rules from the DOL and IRS are complex. Employers are busy running their companies and have little expertise running a plan. Employees are poorly prepared to know how much to contribute or how to invest their money. Because of these three facts, the financial services industry, insurance companies and broker dealers have made a killing at the expense of American workers.”
You don’t have to sit on your hands until January. Ask for full written disclosures about your 401k services and costs, and fiduciary status. Hopefully come January, you can compare it to the required itemized statement.