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Bob's Journal 
What's this?______________________________________________ NOTE: You’ll see the “RSS” block above. We have reactivated this service for those who are interested. You will receive automatic notice when this journal is updated, so you won't have to check in regularly. Click "What's this?" for details. Retirement Watch members will find an expanded version of the Journal on the member's web site at www.RetirementWatch.com February 28, 2007 12:49 p.m. How Our Funds Fared The stock indexes around the world wide took a steep dive yesterday. The numbers for the indexes and many stocks are widely-reported. Let’s take a look at how the funds in our different portfolios held up. Sector and Balanced Managed: Two of our funds have sell signals in place, Needham Growth and ProFunds Ultra Bull. Neither fund is near its sell signal. NEEGX lost 2.68% yesterday and closed at $39.22. Its recent high was $40.30, so the sell signal is $37.48. ULPIX’s recent high was $74.64, making the sell signal $65.68. ULPIX lost 7.04% yesterday and closed at $68.40. Hussman Strategic Growth performed its role yesterday, gaining 1.15%. The net for the portfolio was lost of a little over 2% yesterday, better than the market indexes. IWW Classic Mutual Funds: This portfolio has two real estate funds, Cohen & Steers Realty Shares and Price Real Estate. CSRSX lost 3.11%, while TRREX lost 2.79%. CSRSX triggered its sell signal. Its recent high was $101.19 back on Feb. 7. Yesterday’s close put it more than 7% below that high, so we sell today. TRREX is holding up a bit better. Its recent high was $28.44, giving it a sell signal of $26.45. It closed at $26.50 yesterday. IWW ETF: Spain and Mexico were the iShares funds in this portfolio. Mexico took a big dive yesterday and fell right through its sell signal. We sell it today. Spain held up better. Its recent high was $56.44 on Feb. 20. The sell signal is $52.49, and the fund closed at $53.01 yesterday. IWW ProFunds: The portfolio had Real Estate and Ultra OTC. The portfolio lost over 6% yesterday. Real estate had a recent high of $66.76 on Feb. 7, for a sell signal of $62.09. The fund fell through that price and we will sell it. Ultra OTC had a recent high of $28.11. Since it is leveraged and needs to fall 12% for a sell signal, it stays in the portfolio. It closed at $25.37 for a loss of over 8% yesterday. IWW Rydex: We had Dynamic S&P 500 in the portfolio and just replaced Consumer Products with Real Estate. RYTNX had a recent high of $50.02 for a sell signal of $44.02. It closed at $45.89 yesterday, so it stays in the portfolio despite a 6.95% yesterday. Real Estate had a recent high of $45.97 and closed at $42.72 yesterday, just below its sell signal of $42.75. So we sell Real Estate today. The proceeds from funds sold stay in money market funds until the new rankings come out in the April issue of Retirement Watch. February 27, 2007 01:52 p.m. Is Risk Back? The stock markets were down three days in a row by modest amounts. Then, they started today by declining a sizeable amount and continuing to fall as the day goes on. In the March issue of Retirement Watch, I listed a number of risk factors investors are overlooking that keep our portfolios hedged and cautious. One never knows what will trigger a market correction, or something larger. Today’s problems began in Asia. A few weeks ago I pointed out that Chinese authorities believed their stock market was in a bubble and began taking steps to limit stock prices. Renewed efforts triggered a decline of almost 10% in the Shanghai market. (Keep in mind that market was up over 13% in less than two weeks, so today’s decline puts only a dent in recent gains.) Another concern of investors is in the housing market, specifically the subprime mortgage market. Problems and defaults in mortgages issued to borrowers with less than ideal credit have been defaulting steadily. Importantly, they are going into default a relatively short time after being closed. Usually it takes a few years for rising interest rates to trigger defaults. The rapid rise in defaults could indicate lenders were particularly aggressive and careless. Today the pseudo-mortgage giants Fannie Mae and Freddie Mac issued new guidelines. They will purchase subprime mortgages only if they meet certain guidelines. The new defaults and guidelines raise a fear of a wider spread credit crunch. Lenders who incur losses on subprime mortgages probably will tighten lending standards overall in order to build up reserves to cover the losses. The new guidelines and other directives from banking authorities also could lead to less lending. The defaults likely will put those homes back on the market. There is the potential for housing inventory to rise enough to cause prices to decline further. This reduction in family wealth could lead to less spending. An interesting warning sign to watch is the price of REITs. In the last few years, these have increased steadily with few corrections. In addition, when interest rates fell (as they are today), the REITs increased. Today, REIT prices are declining with stocks, not rising with bonds. That is a sign that some investors are worried about a general decline in the economy. We still are a long way from having these problems spread through the economy and cause a recession. And many stock investors probably were looking for an excuse to sell and take some profits. In addition, today’s stock declines at this point are only 1.5%. A much more substantial decline is needed before we have a correction. But today’s events show why we have been cautiously optimistic and why you need to watch the sell signals. February 23, 2007 03:00 p.m. Why We’re Cautious A major topic among investment professionals is the low volatility of the markets. I provide some data in the March issue of Retirement Watch (posted on the web site). For a long time, stocks have traded without a day of at least a 2% change, and it also has been a long time since stocks have had a 10% or greater correction. Investors are responding to this lack of volatility by ignoring risk in many instances. We see that in the narrow spreads between different types of bonds and continuing surges in assets normally considered risky, such as small company stocks and emerging market stocks. The gains in REITs over the last few years have been remarkable. Recently my pension fund board heard from one of our managers. This very sophisticated manager has underperformed its targets recently. But, unlike most investors, it has declined to increase the risk in its portfolio. In fact, it decided to reduce its risk level. Its reasoning is simple. We should not assume this historically low level of risk will stay indefinitely. It is more likely that risk and volatility will return to historic averages (or higher), and that we won’t get a warning that it is returning. That’s why it is better now to be more risk averse than most investors. There are few investments with a good margin of safety now. It is better to stay balanced and hedged as we are now and preserve our capital for better buying opportunities that are likely to appear in the future. February 23, 2007 02:55 p.m. Lessons from the Tabloids I’ve been avoiding the television news lately, because it is all-Anna-Nicole-all-the-time. But the exposure is so widespread that I could not avoid learning some facts. It appears there are important estate planning lessons for most of us from the young woman’s life and death. 1. Be sure to update your estate plan after life-changing events such as marriage, death of a loved one, birth of a child or grandchild. Apparently the will specifically excludes any children not born at the time of the will (which is very unusual) and was not updated after another child was born. The estate also goes to a son who now is deceased and I gather does not provide clear alternatives. 2. Anyone with minor children should designate a guardian and alternate guardian. Otherwise, a court will decide among competing potential guardians. 3. State your wishes concerning burial arrangements, including location. 4. Establish your domicile and residence. In the recent news, a lot of legal fees have been consumed deciding which court has jurisdiction. That would be avoided if domicile were clear. 5. If you want some privacy, hold property in a living trust and let the trust terms determine who inherits the property. February 18, 2007 02:30 p.m. The New Retirement Catches On The themes of my book, The New Rules of Retirement, are spreading. Two magazines for financial planners recently had special issues on retirement, with an emphasis on the “new retirement.” This is quite a change from the usual issues that focus on asset management and efficient practice management. One major theme people are starting to grasp is that the average retirement will last a long time. A married couple has to plan for at least one spouse living to age 90 or even longer. The retirement fund has to last a long time. Asset managers and financial planners have to move away from the investment strategies that worked in the 1980s and 1990s. They have to focus on ways of making a nest egg last for a long time and to have it pay reliable, rising income for that period. As we have emphasized in past issues of Retirement Watch, reaching those goals requires more thought than simply buying and holding a portfolio designed for long-term growth. One article emphasized that reliability of income is what will matter in the future. There also needs to be an emphasis on insurance and other tools that will prevent a chunk of the portfolio from being used on unexpected expenses. There also is a new emphasis on the non-financial aspects of retirement. Will people be able to work beyond age 70, as many are now saying they will do? How will people fill all that time in retirement? It used to be that having financial security was considered a successful retirement plan. Now, many are learning that finances are only the tool that enables a person to have a fulfilling retirement, doing the things that will make them happy and satisfied and leave a legacy. February 14, 2007 09:55 a.m. Current Issue of Retirement Watch The March 2007 issue of Retirement Watch now is posted on the members section of the web site at www.RetirementWatch.com. Click on “member login” and follow the instructions to gain access to the issue: On the investment side you will find: Managing Today’s Risks: Identifying and managing your portfolio to avoid the many market risks investors today are overlooking. Hedge Funds Continue to Boom: A comparison of our “hedge fund” portfolio of mutual funds with regular hedge funds and a performance update. Top of the REIT Market: Cohen & Steers Realty Shares and other REIT funds continue to soar. What is the outlook? On the non-investment side are discussions of estate planning for family businesses, the best states in which to create trusts, the facts behind the rapid growth of reverse mortgages, key IRA decisions to consider for 2007, and more. Members can read these items and more now. Non-members can join on the web site and begin reviewing my latest advice. February 8, 2007 10:20 a.m. Perils Below the Surface The stock market indexes have been fairly quiet recently. Even earnings season did not generate a lot of momentum in either direction. What has the potential to move the markets, and in which direction will they move? We start with the notion that already priced into the markets are what is known and what people believe is likely to happen. Surprises and the unknown have the potential to move prices. Potential positive surprises are stronger than expected economic growth or lower than expected inflation. Strong productivity increases also are possible market movers. The real puzzle is what could be the potential bad news that would move markets lower? There are several possibilities. The real estate market could be worse than anticipated, as several bears have argued. Today’s news from HSBC holds that as a real possibility. The lender reported that its move into the subprime (poor credit rating) mortgage market has generated higher foreclosures and losses than expected. While this simply could be the result of HSBC and the mortgage company it purchased, it also might indicate that more defaults are on the way. That would lead to greater inventory of homes on the markets, and more price declines. It also could lead to a tightening of lending standards, which would reduce the number of potential home buyers and also put a ceiling on home prices. There is no doubt there is more bad news to come on housing. The issues are how bad that news will be and whether it already is priced into the markets. I do believe that we are in for a long, slow period in housing. But I don’t believe the economy is as housing-dependent as some do. Another potential pitfall is the buyout boom. So far, this has been good news. It pushes up the prices of equities as buyers bid for them. But buyers are paying higher prices primarily because they believe companies are too conservatively managed. One plan in almost all buyouts is to add more debt to the balance sheet. This is reducing the value of some already-issued corporate bonds. It also has the potential to put too much leverage in the economy. I think the main source of potential problems is political. A number of large corporations are abandoning long-time positions to endorse universal medical coverage and new environmental regulations. These changes will reduce economic growth and efficiency. There also is the possibility that the 2003 tax cuts will expire. International isolationism, including trade protection, also is a strong possibility at this point. While I believe that the coming news on economic growth and inflation will be better than most expect, we have to watch these and other trends for their potential to cause the markets to reverse course. February 6, 2007 06:45 p.m. The Markets Behind the Headlines Are big company stocks distorting market valuations? During the last few years of the 1990s bull market, I pointed out that only a few large companies were racking up large gains. Because of the way the indexes are computed, those few companies drove the indexes higher. The vast majority of stocks lagged far behind. Now, the way the indexes are computed is having another interesting effect. As I have pointed out in recent issues of Retirement Watch, the valuations of the indexes have declined even as the stock indexes appreciated because stocks did not rise as fast as earnings. But a lot of this result is due to the lagging valuations of a few of the largest companies. According to a report from Dresdner Kleinwort Group, four companies make up the top 10 percent of the S&P 500 Index, and they have below average price-earnings ratios. These companies are ExxonMobil, General Electric, Microsoft, and Citigroup. And 19 companies have an average P/E ratio of 14, and these companies are 30 percent of the index’s weighting. The smallest 10 percent of companies have an average P/E ratio of 16.2. The same situation is bringing down the index P/E ratios in Europe. More details on this report are here. This effect is one reason we retain hedges and sell signals in our Managed Portfolios. While the economy and stock markets look strong, there are reasons to be cautious about the amount of risk in our portfolio. February 6, 2007 06:55 p.m. Some Lessons in Economics There were a couple of headlines in The Wall Street Journal over the weekend that are instructive to investors. One article reported that the earnings and Nissan were disappointing and did not meet the goals set by CEO Carlos Ghosn. It was only a few months ago that Ghosn had a big cult following as the best CEO in the auto business and the man who could save the American auto companies from themselves. Though he already was running two auto companies, Nissan and Renault, reports often said that the best way for GM or Ford to save themselves was to hire Ghosn or develop a merger or joint venture that would put Ghosn in charge of their companies. I thought the CEO as cult leader movement died in the early 2000s, but it seems that it occasionally comes back. The media were so intent on touting a leader that they overlooked the fact that the two companies Ghosn headed were small players in the industry, and the Ghosn-inspired revival was not old enough to be considered durable. The other article reviewed changes in the fashion modeling industry. For a couple of decades, fashion modeling seemed an ideal job for a young woman. Those who reached the top of the industry made millions of dollars and were flown around the world to wear the most expensive clothes and accessories. Even those who didn’t make the top of the industry earned good livings. Now, globalization has changed that. Those who hire the models discovered a large new labor pool in Eastern Europe and other regions that previously were closed to the West. These models were willing to work for lower fees, and the sheer number of them drove fees even lower. The article described the travails of an 18-year-old woman who was having trouble getting top jobs, having to compete with thousands of others for a few available jobs, and paying her own expenses to try out for the jobs. A few years ago, she turned to modeling because agencies told her that without a college education she should be able to easily earn at least $50,000 annually. It is a clear example of how dangerous it can be to assume that current trends or economic conditions will continue. Things can change quickly, and because of factors that you were not even aware of. It is one more reason why good investment management involves looking for risks and seeking ways to reduce them, instead of focusing only on the potential gains. February 2, 2007 03:10 p.m. Listening to Market Noise It has been a pretty good week for the stock markets, and really a good month. It also has been an instructive week. The biggest lessons were in today’s employment report. For as long as I can remember, investors placed a lot of emphasis on this monthly report. Frequently, markets and investor attitudes change a lot based on this report. Just as frequently, these reactions puzzle me. First, employment is a lagging indicator. The unemployment rate is usually the last bit of data to rise in an economic downturn and the last to improve in a recover. Second, it is notoriously unreliable and subject to revisions. We saw that today, when the number of jobs for the past two months were revised upward by significant amounts. Also, for two years we and others pointed out the discrepancy between the job growth reported in this report and that reported by the Commerce Department. The result was that near the end of 2006 about the employment report was revised to add about 800,000 new jobs for 2006. Third, one month’s data don’t matter. Sustained trends count. For these reasons, I try to maintain a one to three year outlook in our portfolios. I also constantly examine the data to discover which are worth paying attention to and which are noise. Finally, instead of emphasizing forecasts I focus on values and risks. Most advisers and commentators try to forecast the markets and economy, and then position portfolios accordingly. I try to determine the risks that are in the markets and eliminate or reduce those I don’t want to take. I think that ultimately is safer and more profitable. February 2, 2007 03:15 p.m. Continuing Assault on the Academics For a long time I have been critical of the widely-followed portfolio management theory, known as the Capital Asset Pricing Model, or CAPM. I wrote a report a few years ago that addressed some of my concerns, titled Rational Investing in Irrational Markets. My next book, due out around July, discusses the shortcomings of contemporary investing theory in more details. That’s why I always am on the lookout for data and criticisms that support my views. A few years ago, it was difficult to find support from others. More recently, the number of those who agree with me (or those who are willing to say so publicly) is growing. The latest report in accord with my views is from James Montier, an economist at Dresdner Kleinwort. You can read his report here.
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