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Heads in the Sand

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IMF issues broad call for U.S. financial prudence

 

(Registration may be required to access the article online.)

 

Strike anyone as ironic that the US government, always so anxious to support the IMF when it doles out harsh advice or stringent lending conditions to other countries, now finds it so easy to blandly dismiss that same sort of advice when it concerns ourselves??  No, I didn't think so. 

 

Thanks to the Post for publishing this story across the top of the business section. It probably merited an even higher profile, with a particular highlight on the administration's response. (that is, none of any substance).

 

It would be easier to shrug our shoulders and perhaps chuckle at the short-sightedness or ignorance of governmental figures if these issues weren't of paramount importance to all our economic futures. What was true for Argentina earlier this decade, what is true for Greece and Ireland today, is true for any country.  Get your economic and financial house in order by yourself while you still can, or else the markets will do it for you, a result that culminates in catastrophe.

 

Continued Weakening of the Financial Reform Bill

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The bill that continues to evolve from the Congressional conference committee is far below what was expected when that committee first convened.  The issue cited in this article is but one example. Wall Street very quietly has managed to purchase access to this process and is guiding it accordingly.

I suppose it will be interesting to see if, in the end, any Republican support is in fact forthcoming, after change upon change has already been made to satisfy their concerns. If so and the bill passes, then despite it all it will be a significant step forward and will tighten regulation.  If it fails reformers will have thrown away a chance to present a clear vision to the voters about what the sides are and what is at stake.

Perhaps it will end up like the health care bill in which dozens of (mostly bad) compromises were made in a vain attempt to attract bipartisan support.

 

Ways to Cut the Deficit

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Here they are...10 eminently clear and concise ways to cut the federal government deficit, courtesy of Jeff Frankels of Harvard. Perhaps surprisingly, in light of the catastrophic deficit levels of today, there has been a tiny bit of progress on a few of the areas this year. Next year will be more telling now that we are out of crisis mode.

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Nate's Notes From Our Conference Call

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Listen to our November 11, 2009 Investment Conference Call

 
As is normally the case, at any point in time there are positives and negative circumstances in the environment to confront investors. Fortunately, we don't have to dig quite as deeply as we did in spring to locate some positives in the economic world today
 
Positives:
 
The economic decline has ceased. We are no longer retracing the trajectory of 1929-30. Foreign economies are also bouncing back, and in many cases, growing very quickly. In general, the sense of panic that gripped the economic world at the end of 2008 and in early 2009 has abated.
 
Despite the handwringing over the imminent arrival of inflation, it has not occurred. Despite the handwringing over the imminent arrival of deflation, it has not occurred. Core consumer prices are increasing somewhere between 1-2% annualized.
 
Corporate profit margins have held up surprisingly well. Most companies continue to operate "lean and mean" and that is driving strong productivity growth. This is the under-reported positive news about a poor jobs market.
 
The G-7 Group of Industrialized Nations is now defunct, and has been replaced by the G-20. Bringing more - and vital - economies such as China, Brazil, and India into the decision making process can only be a good thing. The group is in frequent conferences and consultations. Free trade has generally resisted any protectionism, with the occasional hiccup such as the United States tariff on Chinese tires. Fortunately, other nations are not following the poor US example.
 
Cyclicality still seems to be the model that best describes the functioning of asset class investments. The most obvious example is the large down and up swings over the past year!  Why would we categorize cyclicality as a positive and take comfort from it? Because the clear implication is that what goes down eventually comes back up. And we have been in a very very down period. Over the past decade the total return from investing in US stocks as defined by the S&P 500 is negative, even including dividends. Cyclicality would suggest a decade of no worse than average returns ahead. This seems even more likely when we think of markets on a global scale and not within the confines of the American stock market and the American economy, which is facing challenges others aren't.
 
Negatives:
 
The most pressing problem facing the American economy - that of excessive spending and borrowing - has not been addressed. In fact, it has been perpetuated with the Federal government replacing the consumer at the borrowing window.
 
In conjunction with this, savers are being penalized - earning nothing on their cash while facing the likelihood of higher taxes. Spending, whether reckless or not, is being encouraged and supported by programs like Cash for Clunkers, cash handouts to first time homebuyers, or various mortgage adjustment schemes to bail out overextended borrowers.
 
The G-20 nor any subset thereof, has not yet addressed in any way the mis-valuations of currencies that continues to destabilize the world economy.
 
Developed world budget deficits are seemingly out of control. Although in many cases, the TOTAL borrowing as a percent of GDP is still salvagable, in other nations such as Japan it appears there is no way back.
 
An opportunity lost - "too big to fail" is now an acknowledged commitment by policymakers. The taxpayers are now officially on call to support "critical" corporations when they become ensnared in difficulties. There is still insufficient (understatement!) regulation of those corporations given the scale of that taxpayer commitment.
 
Summary
 
So, clearly, there are ample positives and negatives and investors are free to choose some from Column A and some from Column B in forming their own views about the future. While we, as always, consider it unwise to try and predict the short-term outcomes for investors (and thus we won't try!) here is how we'd summarize the meaning of the crisis and its aftermath:
 
The crisis revealed the fallacies behind the simple-minded notion that the "market is always right" that underpinned much of the theory of laissez faire economics and whose most prominent supporter was Alan Greenspan. Years, in fact decades, of growing influence by the large financial companies led first to their "capture" of their regulators in the executive and legislative branches and then the transformation of those regulators into aiders and abettors in dismantling the remainders of a proper regulatory structure. The crisis is the bill come due from slavish devotion to an incorrect economic model and the flaws in our system of governance and regulation.
 
And what about the actions that have produced the economic stabilization of today? What are we to make of them? History will be the ultimate judge, but what I believe is that the cost of the crisis will go far beyond the dreadfully high cost of the various stimulus programs. In fact, it could be that we - citizens and taxpayers - have not begun to pay the price at all. As to how this will play out, time will tell.  Something to discuss on our next call, or in further discussions on the website or in our client meetings.

 

Thoughts about the Housing Market

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After looking at some recent and longer-term comprehensive statistics from the housing market, it appears that the worst is behind us and we can realistically hope for normalcy going forward. Why is that?

1) Prices have adjusted. As of 9/30/2009, the median price of a single family home (including condos) was down 21% from three years prior and down 10% from five years prior. Hmmm, and I thought Bernanke was very sure that housing prices would never fall nationwide! Over a ten year timeframe, the gain is a lackluster 26%. So I think we can safely say that prices have corrected.

2) Inventories for sale are much lower, down over 25% from the peak in July 2007. They are still unusually high, but builders have DRAMATICALLY cut back on building, and I wouldn't be shocked to hear of shortages of new homes for sale in the coming years.

3) Affordability is good. With mortgage rates extremely low and prices having fallen, affordability is better than it has been for generations. This is likely to deteriorate some as rates rise (whether that will be gradual or abrupt is unclear) over the coming months and years.

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Actively Managed Mutual Funds Continue to Underperform

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According to recent research by Standard and Poor’s – Standard & Poor’s Index Versus Active Fund Scorecard – a large majority of actively managed US stock mutual funds trailed their benchmarks. Certainly this is not a new development; however, the fact that actively managed funds performed so poorly during the market crash of 2008 must disconcert even their most ardent supporters.

The numbers: In 2008, 54% of large cap funds underperformed the S&P 500; 75% of mid-cap funds trailed the S&P Midcap 400, and a whopping 84% of small-cap funds trailed the S&P SmallCap 600.

Over longer time periods, the numbers are worse. This should not be a surprise, the longer the timeframe, the odds decrease that a manager can randomly outguess an index and overcome the drag from its own expenses. The most startlingly result was that 96% of actively managed small-cap growth funds trailed their benchmark for the five years ending 2008.

Results are similar for international funds.

As sobering as the above results are for stock investors, it is in fixed income where active management has failed most miserably. Perhaps this shouldn’t be surprising either; with yields low, containment of expenses becomes that much more significant and, therefore, expensive active management must overcome a heavier burden, decreasing their chances of success. Over five years, the percentage of fixed-income funds that outperformed their benchmark indexes in the standard domestic bond categories is less than 10%.

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Avoiding a Financial Suicide

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What do I mean by "financial suicide"? Let me ask you, what is the worst possible financial outcome for your life? My answer — that you outlive your financial resources. I wrote this article, Witnessing a Financial Suicide, in 2005, but it is truer than ever today.

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Prophet and Loss

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Many investors are still trying to understand how this economic crisis came to be. Brooksely Born’s story is an eye-opener. I’d like to hear from those who participated in the anti-regulation frenzy. Some of these very same folks are now crafting our strategy for getting out of it! What have they learned?

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What to Do About Banking?

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As we all know, governments throughout the world are wrestling with how to cope from the collapse of the financial system. The U.K. initially received plaudits for its “bold” approach, lately that has come into question as their steps have proven no more effective at stanching the panic that anyone else’s.

To say that there are no easy answers to the catastrophic avalanche of bank insolvencies is trite. At this point, the world would happily settle for a devilishly difficult answer. That answer, when it finally comes, will define the outlook for global finance and economic prospects for a generation.

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The Homeowners Rescue Plan Unveiled

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I guess the effectiveness of this will all depend on the details. Will they FINALLY be announced in specificity today?? Something that sprang out at me as confusing….one class of eligibles will be those who lost their job. And so their mortgage gets reduced to 31% of gross income. Does this mean 31% of unemployment compensation? Their previous salary? Someone’s guess?? Same sort of confusion about someone eligible because of a cut in pay. What if this is just temporary? Do the payments reset back to the higher level after they go back to fulltime?

It does appear that the $1000 gift to borrowers who actually make their mortgage payments has disappeared from the plan. Let’s at least be thankful about that and also cheer the intent of the plan, which is to stabilize the housing market and allow the market processes to adjust housing supply and demand in an orderly way.

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