Bloomberg television is promoting a show airing Thursday in which some prominent investors apparently say that buying subprime mortgages is the best investment for 2012. The show apparently includes people who shorted mortgages and housing in 2007 or thereabout now saying they are buying mortgages. It’s not a bad investment, but they’re a little late. at Retirement Watch, we’ve had our readers invested in mortgage bargains for several years. We’ve been recommended bond funds managed by Jeffrey Gundlach that loaded themselves with mortgage securities purchased from distressed sellers as the market collapsed in 2007-2009. The securities were purchased at low percentages of face value and have generated cash at very low risk to shareholders for several years. I suspect these prominent investors on the show bought their mortgages a while back and are talking about them now because they’re finished buying.
Robert Rodriguez of FPA Capital retired from active portfolio management with an enviable record of mutual fund returns. He achieved superior returns with less volatility while holding high levels of cash from 1998 on. Recently, he gave a sort of valedictory speech and a warning to the Institute for Private Investors. Rodriguez was an early proponent of the idea that a debt and housing bubble was developing and invested accordingly.
His current view is that the problems aren’t over. The 2009-2011 period was an interlude. Because of high government debt levels in Europe, Jpaan and the U.S. and private debt in the U.S., it’s only a matter of time before there is another great crisis. All the liquidity pumped into the economies by central banks makes the situation very volatile and uncertain. He’s recommending that investors focus on the return of their capital first, maintaining high cash and short-term bond positions, and be ready to deploy the cash to capture opportunities that have a high margin of safety.
Phase 2 is now beginning and I think we are on the cusp of a decade of extreme economic and financial market turbulence. Uncertainty as to the effects of high system wide financial leverage and the outcome of the battle to determine what the proper roll and magnitude of government should be within an economy are key elements in this future turmoil.
…
On December 21, the ECB established its new Long-Term Repo Operation (LTRO) that provided €489 billion of three-year 1% loans to 523 banks. At almost twice the expected demand, it demonstrated the seriousness of the banking crisis. A second LTRO takes place on February 29. Shorter-term borrowing costs have declined but longer term sovereign debt yields for Italy, Spain and France, remain elevated indicating that serious reservations persist about the program’s potential long-term success. “Banks represent about 80 percent of the lending to the euro area,” according to ECB President Mario Dragi.9 The linkage between banks and their sovereign governments will likely increase since many expect these loans to be recycled into additional sovereign debt, hopefully into more periphery debt. Additionally, the ECB relaxed its lending standards so that, in some cases, single-A asset-backed securities may now be pledged as collateral. These initiatives are nothing more than rescues or backdoor bailouts that further reward unsound fiscal and financial behavior.
Will this ploy resolve the euro-zone crisis? I believe for only a short period, unless a fundamental restructuring of the EU occurs. Italian Prime Minister Mario Monti’s December budget plan introduced rules that allow banks to issue bonds, guaranteed by Italy, as collateral for loans from the ECB. Playing this game of recycling money to the banks, so they can buy sovereign debt, allowing sovereign countries to go on their merry way, resembles a shell game. It’s DELUSIONAL! I am skeptical there is the will or the ability to reform the EU because it will require ceding fiscal sovereignty to another. The combination of fiscal austerity and rising interest rates means Europe is either near, or already in, recession. The Euro’s structure will face additional tests until at least one or more members exit. Should the weaker countries exit, a stronger Euro is likely. If there are no exits, it means transfers of wealth from the northern to the southern euro-zone countries, which would result in a weaker Euro and a more unstable EU. On January 13, Standard & Poor’s downgraded France, Italy and seven other European countries while assigning France and 13 other euro-zone nations a negative outlook. Without any exits, the next round of downgrades will likely encompass Germany’s AAA status. EU structural uncertainty and high system-wide leverage should make for a difficult European investment environment.
There are two competing strategies for taking withdrawals from a portfolio after retiring. One is known as systematic withdrawals. This is when you set a formula for taking money from the portfolio. The most common formula is a percentage of the original value (usually around 4%) the first year, plus an inflation factor for each succeeding year. The portfolio investment strategy is based on the markets, your age, risk tolerance, and other factors.
The second strategy is known generally as the buckets strategy. Some also call it time-based segmentation. In this strategy, you put money you’ll need in the next two to five years in safe investments. Money you’ll need in up to 15 years is put in a little more risky investments. Money you don’t expect to need for 15 years or longer is invested in risky investments such as stocks.
There’s an ongoing debate over which is the better strategy, and we’ve aired the debate in Retirement Watch. Many people believe the two strategies will have essentially the same investments, but the buckets strategy gives some people more comfort and makes them less likely to sell at the bottom of a bad market.
The Principal Financial Group decided to compare the two strategies with hypothetical scenarios. The white paper (which is available to financial advisors but not to the public) is generally evenhanded but concludes that the buckets strategy is more complicated to implement and might not provide portfolio changes as often and as timely as those offered through a traditional portfolio, such as a target date fund. The buckets strategy does tend to make the investor feel more secure. The systematic withdrawal strategy is likely to generate better financial results, says the Principal.
Greece is going to have to default on its debt. No other conclusion is possible, because there’s no way it will have enough money over any reasonable time to pay the debt. Yet, European leaders seem determined to prevent a Greece default, short of actually giving it cash to pay its debts. While an actual default by Greece would cause problems for many European banks, the problems could be managed with some decent work by central banks and governments.
So, why is the thing being stretched out?
One reason might be the credit default swaps (CDS), which is a form of insurance against bond defaults. When someone lends money or purchases a bond, the person can buy a CDS from a bank or other firm that’s willing to guarantee it will pay the debt if the debtor doesn’t. The reason AIG was bailed out is that it wrote an enormous number of CDS and couldn’t pay them after Lehman Brothers failed in 2008.
But, what happens if the CDS aren’t paid? Would that lead to a lock up of global bond and debt markets? Would people stop lending if they believe they couldn’t obtain insurance via CDS?
Here’s a good analysis of why CDS are the real problem and why we don’t know enough about them to make good decisions. It’s why we need to be cautious with our portfolios regardless of how good the economic data looks and how accommodating the central banks are.
Now traders fear the issue will come back again with a vengeance. The [finance] ministers do not want to see a lot of CDS contracts triggered since they don’t know who owns them or, more importantly, who wrote them. That could become a domino-like contagion ala 2008.
But, traders fear a worse outcome might occur if the CDS contracts do not kick in. What good is insurance that doesn’t pay off. That could lead to the assumption that all CDS insurance was useless. That would stratify debt around the globe. Great credits could get all the money they wanted, but less than great credit would be shut out because it could not be insured. That could make the future one in which “the haves” will have whatever they want and all others nothing. Welcome back to the Middle Ages.
There’s been a lively debate in some sectors of the financial media over the relative merits of stocks and gold. Warren Buffett, Jeremy Siegel and Larry Fink not surprisingly came down on the side of stocks. Others point out the dreary returns from stocks over the last 10 or 12 years, the significant increases in global monetary supplies, and conclude that gold has been the winning investment for over a decade and is likely to continue.
This article does a good job of laying out both sides of the argument while coming down on the side of those favoring gold.
Fink’s and Buffett’s preference for equity investment may have nothing to do with expectations regarding things like economic growth or profits, just money printing. This is not founded on sound economic reasoning, rather simply shifting capital into an ever-rising bath.
What happens when central banks stop filling the bath? Or worse, take the plug out? Or worse yet, find that they are no longer in control of the water?
The investment world does not come down to an all-or-nothing decision between debt (mostly rubbish, now, admittedly) and equity. While the bigger picture is fraught with monetary mismanagement in response to a grave crisis, there are plenty of other investment choices out there, and a growing argument underpinning the ownership of real assets.
On Thursday a settlement was announced of the lawsuits against mortgage servicing companies. The suits charged the servicers with fraud in what was known as the robo-signing fraud. The settlement was billed as costing the services (who also are the country’s largest banks) at $26 billion. But this article argues that the banks actually won and their costs are likely to be far less than $26 billion. It gives 12 reasons you should hate the settlement.
2. That $26 billion is actually $5 billion of bank money and the rest is your money. The mortgage principal writedowns are guaranteed to come almost entirely from securitized loans, which means from investors, which in turn means taxpayers via Fannie and Freddie, pension funds, insurers, and 401 (k)s. Refis of performing loans also reduce income to those very same investors.
3. That $5 billion divided among the big banks wouldn’t even represent a significant quarterly hit. Freddie and Fannie putbacks to the major banks have been running at that level each quarter.
Corporate profits are another concern. They’ve been at historic levels for several quarters, as have profit margins. We’ve been expecting profit margins and earnings growth to shrink, and that time seems to be arriving. I expect central bank money printing to keep a floor under the economy and the markets, but I also believe we need to be cautious because market prices reflect all the good news. Take a look at this summary of the reasons to be cautious about earnings.
But the increase, 5.8 percent, is less than half the speed at which quarterly profits grew the first nine months of 2011. In the average quarter since the beginning of 2010, earnings have grown five times as fast.
Analysts expect profit growth to accelerate later this year. But so far, almost all the growth comes from two companies, one of them among America’s most favorite, the other among its most hated — Apple and the bailed-out insurance company AIG.
Take away those two companies and profits for the remaining 498 are expected to grow a measly 1.1 percent, according to FactSet, a provider of financial data.
I don’t use the P-E ratio much in evaluating the stock market. There are a lot of reasons for that. Earnings are, well, flexible. They’re subject to revisions and manipulation. I definitely don’t recommend using forward, or forecast, earnings, because they can be way off the mark. But the big reason is that earnings are cyclical. Often when earnings and profit margins are at their best is when the economy is nearing a peak and earnings are about to fall, or at least stop growing. Shawn Tully of Fortune puts earnings and P-E ratios in good perspective in this piece. His conclusion is that bullish investors who say stocks are trading at the lowest levels in 20 or 25 years are misreading earnings.
But just because stocks appear cheap based on today’s P/E ratio doesn’t mean they really are inexpensive. The current P/E is a highly unreliable measure of when to buy. The problem is that earnings are extremely erratic, regularly careening from highly inflated to extremely depressed, always reverting from those extremes to long-term averages, as if pulled by a gravitational economic force. When profits are in a bubble, the current P/E is artificially low, wrongly implying equities are a bargain. When they’re depressed, the P/E signals to shun them just when investors should buy. For example, the huge earnings posted in 2006 made equities look attractive, while the paltry profits in 1991 made them look pricey. Investors who bought in 1991 fared far better over the next several years than folks seduced by the ephemeral bargains of 2006.
It seems the bankruptcy trustee for MF Global has tracked down the “missing” $1 billion or so dollars. Apparently the transactions and margin calls during the firm’s last five days were so numerous and frequent that neither the employees nor the computer system could keep up with them. The firm routinely used customer account money to fund its own operations and lost track of it. In normal times, the fund would use the cash during the day and it would be returned before the end of the day and be back in the accounts. But the whole process broke down as the margin calls and cash needs escalated. You can see some interesting flow charts and other information from the trustee here. You can find other interesting details here and here.
But that doesn’t mean the trustee has recovered all the missing assets or that customers are ready to be made whole. The securities that were moved around as collateral haven’t been fully accounted for.
The Fed’s recent announcements make clear to me that it doesn’t care much about the value of the dollar and might even want it to decline. Operation Twist, lending money to the ECB so it can lend it to insolvent banks, and maintaining a zero interest rate policy through late 2014 all indicate other factors are more important than the dollar. Charles Kadlec on Forbes.com says that Fed explicitly plans to devalue the dollar by 33% over 20 years. He figures since the Fed is targeting a 2% inflation rate, that translates to a 33% decline over 20 years.
But, an increase of 2% a year over a period of 20 years will lead to a 50% increase in the price level. It will take 150 (2032) dollars to purchase the same basket of goods 100 (2012) dollars can buy today. What will be called the “dollar” in 2032 will be worth one-third less (100/150) than what we call a dollar today.
The Fed’s zero interest rate policy accentuates the negative consequences of this steady erosion in the dollar’s buying power by imposing a negative return on short-term bonds and bank deposits. In effect, the Fed has announced a course of action that will steal — there is no better word for it — nearly 10 percent of the value of American’s hard earned savings over the next 4 years.
Financial advice writer Suze Orman has generated controversy since she first popped onto the best-seller lists thanks to appearance on Oprah. See here. The controversy continues. Orman’s being accused of recommending financial products for which she’s receiving compensation. Her latest recommendation is for a debit card she endorses and is paid to endorse. She’s also endorsed an investment newsletter that has been questioned. The bottom line is that book publishers, talk show bookers, and other media people don’t do a lot to check out the financial experts they promote. They just want a good show.
After her debit card’s debut, Orman got slammed by critics who wondered how she could responsibly peddle a product that will generate income for her while she’s evaluating competing products.
She responded at first by insulting New York Times columnist Ron Lieber and others, then was shamed into an apology on Twitter.
“For anyone I called an idiot I too am sorry,” she posted on Jan. 11. Two days later, after a National Public Radio host asked about criticism of her card by an online credit-card research site, Orman was back at it. “He was an idiot,” she said of the author of the analysis, who had pointed to “marketing fluff” and the number of fees associated with Orman’s card.
While there’s a lot of fuss right now about Orman flogging her new card, it isn’t the first time she has pitched personal- finance products. Orman sells a $14.99-a-month identity-theft protection product called Trusted ID, which employs a decidedly consumer-unfriendly policy: Buyers must agree to use arbitration in the event of a dispute.
sending...