The Bogleheads’ Guide to Retirement Planning
Taylor Larimore, Mel Lindauer, Rick Ferri & Laura Dogu

“Early retirement planning should begin when you have your first full-time job.”

“No matter what your risk tolerance is, your asset allocation should become more conservative as you approach retirement age.”

“Joint accounts are a great option for ensuring that assets are immediately available to a surviving spouse, child, or partner.”

“Count yourself lucky if you still have a defined benefit plan, but also keep in mind that it may go away in the future.”

“Variable annuities or equity-indexed annuities are products to be avoided.”

“Rather than rebalancing by the calendar, many people make changes only when their portfolio allocations are off by a certain percentage.”

“Each time you need to withdraw money from your investments, simply look at your asset percentages and take the money out of the one that is overweight.”

“Reverse mortgages should be a last resort for providing income.”

Your greatest asset is your ability to earn a living for yourself and your family.”

For younger breadwinners, term insurance is the only practical way to provide needed protection at affordable costs.”

“The more complex the product, the worse it is for you, and the better it is for the adviser.”

“Certain assets, such as life insurance … pass to designated beneficiaries if you die. A divorce decree will not change the designations.”

“In the real world, people lose jobs, good health turns bad, more than half of marriages end in divorce, and other setbacks occur that can ruin a good retirement plan.”

The Coffeehouse Investor
Bill Schultheis

“The investor who starts saving and investing $300 monthly at 8% in a retirement account at age 25 instead of age 35–ends up with an additional $604,195 in her portfolio at age 65.”

“When fear and greed aren’t controlled, buying and selling individual stocks can quickly become a miserable experience.”

“As long as Wall Street has a vested interest in lots of transactions and busy portfolios, investors will continue to latch on to the hype and hysteria of Wall Street, perpetuating the misconception that by carefully reviewing market trends, diligently studying mutual fund tables, religiously researching global economies and closely watching interest rates, anyone and everyone can own a successful portfolio.”

“Let go of the mistaken belief that the secret to a successful portfolio is to accurately forecast bull and bear markets.”

“The simplest approach to diversifying your stock market investments is to invest in one index fund that represents the entire stock market.”

“The top 35 mutual funds from 1978 to 1987 cumulatively under-performed the stock market average by 7% annually during the next ten years.”

“The most important factor when diversifying is to adhere to your asset allocation strategy, because when you stick to your strategy and rebalance your asset at year-end, buy and sell decisions are no longer arbitrary.”

Common Sense on Mutual Funds
John C Bogle

“To invest with success, you must be a long term investor.”

“Suppress the temptation to add redundant layers of diversification.”

“After nearly 50 years in this business, I do not know of anybody who as done it (market timing) successfully and consistently.”

“When stock prices are high, investors want to jump on the bandwagon; when stocks are on the bargain counter, it is difficult to give them away.”

“The key to fund selection is to focus, not on future return–which the investor cannot control–but on risk, cost, and time–which the investor can control.”

“Backtesting, of course, should always be viewed with skepticism.”

“Choose a balance of stocks and bonds according to your unique circumstances–your investment objectives, your time horizon, your level of comfort with risk, and your financial resources.”

“Asset allocation is critically important; but cost is critically important, too. — All other factors pale into insignificance.”

“Most of all, beware of wrap accounts–packages of mutual funds assembled within a ‘wrapper’ for which an additional fee is paid.”

“The ‘Equity Risk Premium’ is the extra return required by investors to compensate them for taking the extra risk of owning common stocks rather than risk-free U.S. Treasury bonds. The average since 1802 has been 3.5%”

“The simplest of all approaches is to invest solely in a single balanced market index fund–just one fund. And it works.”

To be continued …. here.

Time to wake up Canadian investors and do some foreign diversification. Shake off the cobwebs of inertia and go shopping for U.S. assets with your much enhanced purchasing power! 

But the $64,000 question is (in U.S. dollars, of course): which U.S. assets to buy? 

Stocks are a bit scary at the moment because they have run up so far so fast. Halloween might be more trick than treat this year murmur the goblins — one being Gluskin Sheff strategist David Rosenberg. He has the DNA of a bear but we still might want to take note of his point that stocks typically haven’t gone up by this much until the second or third year of the business upturn.  

Still, there may be some pockets of undervaluation in the U.S. stock market. It might take awhile, but I can see the SPDR S&P Homebuilders ETF (XHB) being much higher. The U.S. housing market was ground zero and still looks like it. There remains a big wall of worry to scale and a lot more recovering to do.

U.S. stocks in health care, technology, consumer products and other areas underrepresented on the Toronto Stock Exchange, can add diversification to a portfolio of Canadian stocks. A recent John Heinzl article mentioned some picks in this regard. We could add some ETFs such as the PowerShares Dynamic Pharmaceuticals (PJP) and iShares Dow Jones U.S. Healthcare Providers (IHF) funds. They are in health sectors that should emerge as winners once the overhaul of the U.S. healthcare system is complete, according to Reuters.

Bonds might not be such a steal anymore either but with stocks having run up so much and now likely exceeding chosen allocations in portfolios everywhere, it might be more prudent to go with bonds at this stage. Indeed, the year-end rebalancing is coming up for many investors and allocating toward bonds will be the path they have to go if they are to stay disciplined. And, of course, if you are near retirement or have trips/sojourns planned in the U.S., fixed-interest investments are the way to go.

High-yield bond ETFs are still offering yields in the vicinity of 10%. Examples are SPDR Barclays Capital High Yield Bond (JNK) and iBoxx $ High Yield Corporate Bond Fund (HYG). High-yield bond ETFs are not available in Canada, so they would be a welcome addition for investors reaching for more yield in their fixed-income allocations.

Many other, more conservative, bond ETFs are available. The ones tracking short-term bonds, such as the Vanguard Short-Term Bond ETF (BVS), are less exposed to capital loss and their interest rates will move up more quickly if market rates rise. A U.S.-dollar savings account has no price fluctuations to worry about; rates are low (ING Direct pays 0.75%) but should move up as the economy recovers.

Some other ideas for buying U.S. assets that I have posted on before: 

- Probably the cheapest of U.S. assets to buy right now is real property — unlike other assets, prices still haven’t gone up much (although the work involved in carrying out a transaction is onerous) 

- Another idea is to buy Canadian assets in line to benefit from the soaring loonie, such as shares in Canada’s largest travel-tour operator, Transat A.T. The high loonie means it’s more affordable for Canadians to visit and/or stay in the U.S., which plays to Transat core business of arranging foreign travel and accommodations.

A final note: the loonie could even go past the peak of $1.10 (U.S.) attained in 2007, say some forecasters. Spacing of asset purchases over time would average out the timing risk.

I would think longer term. There will invariably be a reversal at some point. But we have just been through a substantial recession and the central banks are now goosing the money supply big time. Historically, this kind of scenario spawns an extended multi-year appreciation in stocks, characterized by higher highs and higher lows. Your best bet will likely be to sit tight and ride the longer swing.

Excessive trading of peaks/valleys or rebalancing of holdings raises costs that eat into returns over the long run. There is also the issue of market timing. It’s very hard to sell near the peak and buy back in at the bottom of short-term fluctuations – the end result will likely be a lower return than simply holding.

Rebalancing, of course, has its place. Many investors do it annually and this would make sense for those concerned about maintaining a risk level they are comfortable with. However, those with high risk tolerance might not worry about annual rebalancing for two or three years in the current environment.

They could in time become concerned about the bull market ending. In that case, they may consider techniques such as “risk budgeting,” as Mark Yamada of PŮR Investing Inc. epsouses. Or simply begin a regular annual rebalancing.

Index-fund pioneer John Bogle has said he doesn’t think rebalancing is necessary at all. If one is a true believer in the thesis that stocks return 7% to 9% annually over 15- to 30-year periods, then all that volatility along the way does not need to be hedged away with rebalancing.

Falkenblog had a post making this argument with more than the usual gusto. Main points:

Arithmetic vs. geometric averages: when an index goes from 100 to 200 and back again, the average annual return on an arithmetic basis is 25% (200/2 + 50/2 = 125). The geometric average, which shows 0% change, would seem to be more relevant to the long-term investor.

Survivorship bias: the U.S. had the best stock market in the 20th century –it’s not a good benchmark for what to expect going forward on average.

After-tax returns: taxes applicable to the equity premium reduce the margin (even in RRSPs since they just defer taxes).

Market timing: dollar-weighted returns, reflecting high inflows at peaks and outflows at troughs, are lower than time-weighted returns.

Transactions costs: “commissions were about 60 cents/share until the 1975 deregulation and are currently about 2 cents a share (about 0.1%) on average. Plus, mutual funds often had 8.5% fees. …. the bid-ask spread will cost you about 0.25% on average….”

Add up all these factors, and the equity premium shrinks to zero or worse for the average investor, says Falkenblog.

Food for thought, as they say. Personally, one issue I am wrestling with is: even if the equity premium does exist, how can it be expected to persist? To rephrase, how can one reconcile a positive equity premium with the efficient market theorem.

The latter says a systemic opportunity to profit doesn’t persist in the stock market because market participants capture such profit opportunities by biding stock prices up or down until the anomaly is eliminated. Yet, the equity premium says there is a systematic opportunity to profit in stocks by buying and holding over the long run.

Ten or fifteen years ago, there weren’t many books or studies alerting investors to the premium, so not many were responding to it. But now everyone knows about it, so we might expect many investors to have incorporated it into their strategies (or be in the process of doing so). Just look, for example, at how much pension funds and other institutional investors have shifted out of bonds toward equities over the past 10 to 15 years.

The end result may be that stock prices have been bid up relative to long-term fundamentals such that the equity premium will turn out to be close to zero or negative (at least more so for investors who buy during the mature  bullish phases).

You may recall his first book of a few years ago: Smoke and Mirrors: Financial Myths that Will Ruin Your Retirement Dreams. He took aim at financial planners and advisers, labeling them salespersons using scare tactics and “rule of thumb” methods to vacuum money out of the pockets of clients.

Take the rule that one needs 70% of their income or $1 million to retire. Trahair argues 40% will do the trick. He also challenges the mantra that one does not have to worry about investing in stocks over the long run. Getting into stocks is like signing up for a ride down the Niagara River where eventually one faces the prospect of going over the falls; the few extra percentage points to be earned (in theory at least) just aren’t worth the volatility and uncertainty over the final outcome. And paying down your mortgage would be better than contributing to RRSPs: it effectively yields a certain return of 5% to 7% as opposed to the risky returns in stocks and lower rates on fixed-income.

Trahair has put the introduction to his new book online at his website and it gives a few hints what will be in it. Here is what will likely be on the hit list:

• Smith Manoeuvre and borrowing to invest
• Maximizing RRSP contributions each year
• Stocks for the long run
• Getting rich automatically by skipping the daily Starbucks
• Paying an advisor 2% a year to beat the market

What will be the investment strategy recommended? Well, stocks look like a no go. That leaves fixed income, most likely a ladder of GICs.

The study, authored by Lily Fang and Joel Peress, is to be published in a forthcoming issue of the Journal of Finance under the title “Media Coverage and the Cross-Section of Stock Returns.” The authors note that the outperformance of stocks not covered by the media is particularly large among i) small caps, ii) stocks with low analyst coverage, iii) stocks primarily owned by individuals, and iv) stocks with high volatility relative to the market. For some of these subclasses, the annual premium ranges from 8% to 12% after risk adjustments.

Highlights from other studies

Another study in the genre is Paul Tetlick’s, “Giving content to investor sentiment: the role of media in the stock market,” which was published in the Journal of Finance in 2007. He did a word-content analysis of one of the most widely read summaries of daily stock market activity, the Wall Street Journal’s Abreast of the Market” column, from 1984 to 1999. He found that a rise in the number of pessimistic words in the column foreshadowed a market downturn the next day.

Tetlick’s view is that professional investors have their own sources of information such that they usually know about the information before it gets published in the media. Readers of the media are thus reacting to “stale” data, causing an overshoot in prices. After they drive the prices of mentioned stocks up or down, sophisticated investors will return prices to their fundamentals by buying the stocks experiencing media-induced dips and/or shorting the stocks with media-induced spikes.

In a 1990 Journal of Business article, “Clearly heard on the Street: The effect of takeover rumors on stock prices,” there is a similar message that new information tends to be discounted in the market before it appears in the media. Authors John Pound and Richard Zeckhauser examine the impact of takeover rumors published in the Wall Street Journal’s “Heard on the Street” and finds “trading strategies based on buying or selling rumored targets’ stocks yield zero excess returns. They also observe that stock prices of rumored takeover targets run up in the month before publication.

In “All that glitters: The effect of attention and news on the buying behavior of individual and institutional investors,” Review of Financial Studies (2007), Brad Barber and Terry Odean confirm the “hypothesis that individual investors are more likely to buy than sell attention-grabbing stocks, e.g., stocks in the news, stocks experiencing high abnormal trading volume, and stocks with extreme one day returns.”

Paul Tetlock, Maytal Saar-Tsechansky, and Sofus Macskassy find in “More than words: Quantifying language to measure firms’ fundamentals,” Journal of Finance (2007) that the fraction of negative words in Wall Street Journal and Dow Jones News Service stories about individual S&P 500 firms from 1980 to 2004 predicts earnings and stock returns.

Felix J. Meschke’s Arizona State University 2004 working paper, “CEO interviews on CNBC,” concludes that stocks of companies whose CEOs were interviewed on CNBC between 1999 and 2001 experienced a strong run-up initially, but in the following days exhibited strong mean reversal so that the “abnormal” cumulative return (i.e. return relative to market) was -2.8%

Getting back to the low “would be consistent with over $5.0 trillion of debt elimination,” says Rosenberg. This is too much for even the U.S. government to absorb, he declares: “A goodly chunk of this excess debt — bringing credit into realignment with the permanently new and lower level of household net worth — is going to have to be paid down (or defaulted on).” Hence, Rosenberg’s bullish stance on government bonds and bearish stance on stocks.

No doubt some of the debt will be extinguished, as it should be. But there is also a denominator in the debt-to-asset ratio. It can move up and take the ratio lower too. Indeed, the previous declines and cyclical lows in the series may mostly reflect, it seems to me, periods of asset inflation brought on by Fed monetary expansion. Something similar could happen again this time around.

Just as I’m not sold on the view we are heading for a raging inflation problem, neither am I personally sold on the debt-deflation thesis. Never underestimate the power of policymakers to pull rabbits out of the air or do whatever it takes to save the system. The bears are right about the system being in need of a great purge but the government is the “house” in this great casino.

Back then markets came back strongly after the initial crash of 1929 and rose through the spring of 1930. But that was only a false rally before the stock market cratered again and the Great Depression got off to its official start.

Some suggest we’re at a similar point now. Ongoing debt deflation has yet to run its course and the economy has further to readjust yet, all of which is going to take markets lower end leave this boom a good chance to sell out before the big crash. It is the ultimate bearish stance. But the bears seem to have some corporate insider data to back them up.

One of the best forward signals there is about corporate behaviour is the buying or selling patterns of corporate insiders. Insiders have access to privileged information at a company, and so when securities reports suggest they are selling it’s often taken as a signal the companies they work for are going to do worse in the years ahead. (And on the contrary. When insiders are buying it’s a signal corporate executives are optimistic).

So the fact that there was a massive spike in insider selling this past April (at a rate of 20-to-1), suggests that many in the corporate sector think things will get worse in the months ahead and were taking this rally as an opportunity to lock in some higher gains.

Sure, many economic indicators appear to have bottomed. And we may now be sailing into an economic recovery. But we’ve also seen an amazing amount of economic stimulus provided to markets, and so that has to have something to do with what’s going on right now. At the very least that stimulus has to represent the end of the collapse. But does that necessarily mean this is the beginning of a recovery? The SUV and McMansion sector of the economy has collapsed. But we may yet need to get through a disaster in the airlines and it looks like Citibank and Well Fargo have got to raise a lot of capital yet after their stress tests. And the price of oil is trebling at around $50, ready to run as soon as growth returns and flare out the economy again. Taken together, it’s not clear the burn-off of the old order is done, and that a base has been laid for long-term growth. At leat that’s what the insiders are saying.

Stress tests may have some teeth after all

Krishna Guha, Financial Times of London
“A Fed white paper on the tests revealed that regulators ignored recent changes that water down mark-to-market accounting rules when assessing how much of a capital buffer each bank needs to ensure that it could comfortably survive a deeper recession than expected.
This is likely to result in some banks having to raise more equity than they would have done if the new accounting guidance had been applied, resulting in a stronger capital buffer but also greater dilution for existing shareholders. Regulators also took an expansive view of the risks banks need to hold capital against, including off-balance-sheet exposures and counterparty credit risks.”

Insiders dumping shares

Michael Tsang and Eric Martin, Bloomberg news
“Executives and insiders at U.S. companies are taking advantage of the steepest stock market gains since 1938 to unload shares at the fastest pace since the start of the bear market”

The coming tidal wave of corporate bond defaults

Floyd Norris, New York Times
“So it went with the subprime mortgage crisis. And so it is now going with corporate loans and bonds. It appears that defaults on leveraged loans and corporate bonds will soon rise to levels not seen since the Great Depression …. One reason for the rise in defaults is that this is a severe recession. But it is not the principal one. Junk, circa 2009, is the worst junk ever …. Calculations by Moody’s Investors Service show that as of the beginning of April, a record 27 percent of speculative-grade debt issuers had a rating on their senior debt ranging from Caa down to C.”

Banks getting the wrong medicine

Daniel Hofmann, chief economist at Zurich Insurance Co.
“… big, troubled U.S. banks represent a large part of that country’s economic woes, but are being given the wrong medicine … The problem …is that the U.S. government has been treating banks as if they had a liquidity problem, while in fact they have a solvency problem …. The two problems are very different: you need liquidity if you owe $100 tomorrow, but your only asset is a $100 item that will take a week to sell. All you need is a short-term loan …. But if you owe $100 tomorrow and your sole asset is worth just $50, you have a solvency problem ….Those who see a solvency problem don’t believe that all the U.S. plans to create a market for bad bank assets will work. These plans assume that the assets have significant value and buyers just need some encouragement …. But if the assets are worth very little, some big banks are insolvent. Then, the only cure is to close them, let their investors and lenders take a loss and peddle the assets for whatever they’re worth …. If that’s the case, the longer government waits to administer this bitter medicine, the longer the U.S. will have a hobbled banking system and substandard growth.”

Retest of March low coming?

Mark Hulbert, MarketWatch
“… new bull markets often retest the lows of the bear markets that preceded them. That means that, even if a new bull market is now underway, it is not necessarily essential that you immediately increase your equity exposure …. Consider what happened after the 2000-2002 bear market came to an end on Oct. 9, 2002 .. The bottom line? Even if the train has left the station, there’s still a good chance that it will return to pick up more passengers.”

One argument against having the Big Rally in 2009 is that it’s still too early. During the Great Depression, it came 4 years after the peak of the previous bull market. We are only about two years past the peak of the last bull market. Then again, policymakers this time around reacted with massive stimulus sooner than was the case in the 1930s, so perhaps the Big Rally could get here sooner.

Ultimately, it will be up to the economy. “It was early glimmerings of a recovery in the U.S. economy that ignited and fueled the rally; the tone of economic data over the next few months should be what keeps it going or not,” I wrote in an earlier post, Is this rally for real?

So let’s generate another installment in the mash-up that was started in the above post and continued in a second post, Rally Gone Overboard? This time the focus is more on the real economy than financial markets (as it was in the previous post). Again, the flow of data and commentary has a large strand of skepticism. But some of it does shine a light.

Highlights from the data/comments flow

Optimism may be fashionable, but there are plenty of reasons to fear it is premature. The upbeat thesis focuses on firms and their inventories ….The danger, however, is that too much emphasis on the [inventory] cycle misses the underlying characteristics of this downturn. This is mainly a balance-sheet recession precipitated by a financial crisis. And it is a downturn that it is unusually synchronized around the globe. Economist magazine.

“The recession is very likely to end sooner than people think [ECRI's weekly leading indicator of economic growth, which has a good record of predicting business cycle turns, just hit a six-month high]” Lakshman Achuthan, managing director at the Economic Cycle Research Institute, (ECRI).

A Reuters/University of Michigan measure of U.S. consumer moods jumped more than four points to 61.9 in April, the highest reading since September.

“In March, the year-to-year decline in U.S. industrial output of 12.7% was the result of reduced U.S. demand, inventory cutbacks and recessions abroad … it was the largest since the factory sector’s wind-down following World War II,” Haver Analytics.

“… deleveraging by highly leveraged firms, such as hedge funds, will lead them to sell illiquid assets in illiquid markets … [and] some emerging-market economies, despite massive IMF support, will experience a severe financial crisis with contagious effects on other economies,” Nouriel Roubini, Professor of economics at the Stern School of Business.

The CBOE Market Volatility Index was 36 on April 16, edging down from the 40 level of recent weeks and noticeable lower than the peak of 80 in October 2008. But before the bear market, the VIX was hovering near 10.

The $787 billion stimulus program is flawed because too much spending comes after 2009, and because it devotes too much of the money to tax cuts, Nobel prize economist Joseph Sitglitz.

“ … there are some encouraging signs that support cautious optimism. I do not expect a strong recovery but I do expect the economic contraction we’re now experiencing to give way to slow and tentative growth as early as the third quarter.” Dennis Lockhart, president of the Atlanta Federal Reserve

“Over just the last three months, business inventories have fallen at a 15.2% annual rate, a record for the series which dates back to 1980 … Lower business sales [and prices] continue to propel the inventory correction … they are down at a 16.2% annual rate over the last three months … The inventory cutbacks overall, however, have done little to reduce the I/S ratio for total business … It remained in February near its highest level since 2001,” Haver Analytics.

“Taken together, both (housing and jobs) releases will put a damper on the nascent optimism we’ve seen in the markets in the past couple of weeks,” Matthew Strauss, senior currency strategist at RBC Capital Markets.

“Consumers spent less [in March], sending sales skidding 1.1 per cent from February …
This week’s Chapter 11 filing by General Growth Properties, the second-largest mall owner in the U.S., [could be] a bad omen for what ails the U.S. economy … If consumer spending stalls at current low levels, brace yourself for more retail and mall bankruptcies, in the U.S. and elsewhere.” Barrie McKenna in the Globe and Mail.

The fundamentals in terms of corporate profits, house prices and bank lending have not yet bottomed; valuations are not yet at fire-sale levels — the cyclically adjusted price-earnings ratio is 14.5 compared with previous bear-market lows in single digits. Teun Draaisma, Morgan Stanley strategist

But what a wall or worry it is this time. Did those buying really do their due diligence and check the fundamentals carefully? Or are they simply letting Mr. Market tell them it’s the time for climbing the wall of worry? Or worse, are they caught up in a buyer’s panic and motivated by the fear of being left behind?

These were the questions that came to mind when I found some more time to resume the mash-up of highlights from the stream of data/commentary on the current/future state of the economy and financial markets. When you step back a bit and listen to some other voices besides Mr. Market’s, there seems to be a rather wide disconnect between the two.

What follows pertains to just the financial sector, which has been mainly responsible for the stock-market rally in the U.S. I hope to cover other aspects in subsequent posts.

Highlights from the data/comments flow

Green shoots are appearing and we will be watching for more signals that will herald the economic recovery. For now, it is not self-sustaining economic growth yet. Stability in the financial sector, with clean balance sheets of banks and a working credit machine, will be necessary for self-sustaining economic growth. Northern Trust economists.

Some of the largest mortgage companies are stepping up foreclosures … [they] had stopped foreclosing on borrowers as they waited for details of the Obama administration’s housing-rescue plan [and for other reasons] … now, they have begun to determine which troubled borrowers … to move through the foreclosure process …. The resulting increase in the supply of foreclosed homes could further depress home prices and put additional pressure on bank earnings as troubled loans are written off. Wall Street Journal.

U.S. foreclosure activity was up 46 percent in March from a year earlier, hitting a record high as programs stunting the torrid pace of failing mortgages expired. RealtyTrac.

More than 2.1 million homes will be foreclosed in 2009, up from about 1.7 million in 2008.Economy.com.

Credit offered by the 21 largest banks receiving TARP funds fell 2.2% in February compared with the prior month. U.S. Treasury Department.

Like the other US banks that reported first-quarter earnings this week, Citigroup was desperate to appear as healthy as possible ahead of the Treasury’s stress test results, which are now just weeks away …. But Citi will have $80B of tangible equity versus assets of $2,000B … that is still worryingly geared. LEX, Financial Times of London.

It does not help that many banks have not set aside enough reserves for credit losses –Wells Fargo holds an array of assets at rose-tinted values and may need another $25 billion in capital on top of the $25 billion it has already taken from the Treasury. Few banks hold their commercial-property portfolios anywhere close to 50-60 cents on the dollar. Economist magazine.

The banks will face more pressure because their legacy loans have not been marked to market …losses on the banks’ loan portfolio are likely to rise to 3.5% by the end of 2010, which would exceed Depression Era losses … the banks aren’t factoring those losses in yet. Mike Mayo banking analyst for Calyon Securities.

The banks will not see profits after the first quarter … home prices will fall another 30%. banking analyst Meredith Whitney

Home prices will fall 22% to 27% from their January levels. Ronald Temple, a director of research at Lazard Asset Management.

The negative dynamics between the real and financial sides of the economy have created severe downside risks … [financial markets remain highly stressed, making them an impediment to recovery] …While we’ve seen some tentative signs of improvement in the economic data very recently, it’s still impossible to know how deep the contraction will ultimately be. Janet Yellen, president of the San Francisco Federal Reserve.

My latest estimates are $3.6-trillion in losses for loans and securities issued by U.S. institutions …. It is said that the International Monetary Fund will announce a new estimate of $3.1-trillion for U.S. assets … By this standard, many U.S. and foreign banks are effectively insolvent …. Nouriel Roubini, Professor of economics at the Stern School of Business.

The Obama plan to fix the banking system is destined to fail … The people who designed the plans are either in the pocket of the banks or they’re incompetent …. TARP isn’t large enough to recapitalize the banking system … weaker banks should be put through a receivership where the shareholders of the banks are wiped out and the bondholders become the shareholders. Nobel prize economist Joseph Sitglitz

More representative of the state of the banking system arguably is Capital One Financial, which reported late Wednesday a surge in credit-card losses in March, to 9.33% from 8.06% just a month earlier. Randall W. Forsyth in Barron’s

Financial stocks leading this rally have run 26% above their 50-day averages — the widest gap in almost two decades. Kopin Tan in Barron’s

More blows are coming. Banks worldwide have written down their assets by $1.1 trillion. The final tally is expected to be double that, or more. The pain is only now starting to spread through commercial property and commercial loans. As a result, the first-quarter reprieve will turn out to be a “head fake”, says Chris Whalen of Institutional Risk Analytics. Economist magazine.

What will ultimately decide the market’s fate, I believe, is the flow of economic reports over coming weeks. It was early glimmerings of a recovery in the U.S. economy that ignited and fueled the rally; the tone of economic data over the next few months should be what keeps it going or not.

Let’s do a mash-up of some highlights from the stream of data received to date and see if that gives any suggestions of future developments. Commentary on the data is worth highlighting too. What’s interesting about the latter is the generally skeptical tone (with some exceptions). Is the market climbing the proverbial wall of worry or will it again fail to make the leap?

One the more important economic signals that got the party going came from the ISM manufacturing survey in March. It showed the US economy was contracting at a less rapid pace by edging up to 36.3 from 35.8 in February. Particularly of note, the New Orders Index of the ISM manufacturing survey rose over three straight months, from 23 in December to 41 in March. Inventory rebuilding was cited as the cause.

Norbert Ore, chair of the ISM manufacturing survey committee, cautions: “There is a tremendous purging of inventories taking place and I think there’s still more that needs to be worked through because demand just isn’t absorbing it fast enough.” Another key leading index in the ISM manufacturing survey, the Vendor Deliveries Index, was down 46.7 to 43.6 over the last three months.

There has been some green shoots sighted in the U.S. housing sector. The February Pending Home Sales Index, which foreshadows house sales by 1 to 2 months, increased to 82.1 from 80.4 in the prior month. The Mortgage Bankers Association’s Refinance Index has climbed from the 2000 level in late 2008 to the 6000 level recently.

Yet inventories of house for sale remain high and house prices continue to tumble. The Case-Shiller Home Price Index dropped in January by 19% from a year ago, following an 18.6% year-to-year decline in December.

There isn’t much confirmation from the bond market. according to some observers. The spread between Moody’s Baa bonds and 10-year Treasury Note is over 500 basis points compared to 300 basis points a year ago; spread between ML Junk Bond and 10-year Treasury Note is close to 1600 basis points versus 800 basis points a year ago.

But a leading forecasting firm is bullish. “With [our Weekly Leading Indicator] rising to a 23-week high, an upturn in the U.S. growth rate cycle is now in clear sight,” said Lakshman Achuthan, managing director at ECRI

John Ryding, chief economist of RDQ Economics, on the Obama stimulus package: “… a lot of the so-called stimulus package doesn’t occur until beyond 2010.”

While unemployment trends are considered lagging indicators, parts of the employment data are leading indicators. Of note in the last report, temporary help lost 72,000 workers and total hours worked fell by 1%. The average work week was 33.2 hours, the lowest since records began in 1964.

‘The Economy Is Contracting A Lot More Rapidly than the Government Is Reporting,’ says the headline to a TrimTabs press release. “Job losses have been accelerating in recent months,” said Charles Biderman, CEO of TrimTabs. “Investors who think the economy is bottoming out are going to get quite a shock this spring.”

Billionaire speculator George Soros says in an interview that the market rally is unsustainable. He believes policymakers “did not succeed in recapitalizing the banks to the point where they can lend freely.”

Standard & Poor’s reports there was a record high in the first quarter for the number of companies cutting dividends (367) and a record low for the number raising them (83). “On current estimates, S&P 500 dividends will fall 22.6 per cent this year – the worst year since 1938,” writes John Authers of the Financial Times. He adds: “According to Moody’s, March saw the most global speculative-grade defaults in any month since the Great Depression.”

“There has been a lot of speculation about which corner of the economy is likely to implode next and start to write the next chapter in the current financial crisis. Credit card debt and commercial real estate are two of the most frequently cited potential culprits, but lately Eastern European banks have been under great stress …” comments a chat-room visitor.

“Baltic Index is falling again,” notes another chat-room commentator.

The Treasury is delaying its report on the stress tests of the top financial institutions. Likely means bad news, speculates Mike Shedlock of the Global Economic Analysis blog.

Pimco’s co-CEO Mohammed El-Erian has cut his exposure to stocks to 30% (versus 60% normally). He told CNBC that two out of four conditions need to be met for an economic recovery to begin: house prices need to stabilize, banks must start lending again, the consumer must start spending again and the rest of the world must pick up. “For the moment, only the fourth condition is partly fulfilled, with timid signs of recovery in China emerging,” he said.

Sorry, folks. There is more to add but I gotta get ready for a meeting.

1. If you are doing-it-yourself (DIY) simply to avoid having to pay mutual fund fees or investment advisory fees, remember that your time is money too. You have to spend quite a bit of time to learn and understand the investment environment as well as financial markets. Make sure you are willing to invest the effort. Half measures are not rewarded.

2. Don’t invest in something unless you are absolutely certain you understand how it works. This may sound like a cliché, but it’s critical that you perform your due diligence from beginning to end. Remember that if something goes wrong, you only have yourself to blame, and there is nobody else to sue.

3. To be a successful DIY investor, you must truly and honestly enjoy the process of investing and relish financial minutia. This is not something you can do out of guilt or necessity. If you treat investing like the odious 60 minutes at the gym every week, or like eating your spinach, you will fail miserably and regret it.

4. Have a personal investment policy statement (IPS) and make sure to place limits and restrictions on your leveraging, margining, short sales, etc. The buck stops with you, so make sure to have a plan. Don’t be a cowboy.

Analyzing trading data from the Australian stock market between 1990 and 2005, the paper finds that individual investors at discount brokers lose to institutional investors and individuals at non-discount (e.g. full-service) brokerages over nearly all trading periods. That is, their buys underperformed their sells, in contrast to institutionals and clients of full-service brokers.

One major reason for the underperformance was trading just after the exchange opened for business. Since institutionals and full-service clients have better access to research and other information sources, discount-broker clients trading just after the opening bell are operating with less information on overnight developments.

Another major reason is that discount-broker clients do not have the same facilities or time for monitoring their limit orders — so they may get “picked off.” They may, for example, put in an order to sell a stock at $30 when the price is $25, and if the price suddenly jumps to $40, investors more closely monitoring the market may pick off the investor with the limit order at $30 — and pocket the extra $10.

Who Win and Who Lose Among Individual Investors?
Kingsley Fong, David Gallagher and Adrian Lee
February, 2009

Many traders are expecting a climax of selling some day in the near future, with the markets dropping more than 10%, at least on an intraday basis. If a day like that comes along, it may be a good time to get brave and put the explore part of your portfolio to work with a bet on some double-long, exchange-traded funds. The market should be close to snapping back.

It’s interesting that stock markets have fallen decisively below their November lows, yet, measures of fear in many cases are still noticeably below the levels reached during the earlier market lows. Take the VIX. It has climbed but is still just at 50, compared to 80 back in the fall.

The decline has been too orderly. That’s one reason for expecting the bottom still lies ahead. We need to see the gauges of fear soar yet again to signal the bottom

But it’s possible that the VIX and put/call option trading won’t spike as much this time around, says James Kostohryz of Minyanville. “Options traders are relatively sophisticated and most aren’t brazen enough to be shorting the market at these depressed levels. That to me is explaining the lack of a spike in put/calls and the VIX,” he writes.

Look at other indicators, he suggests. Some of them are signaling capitulation: for example, the American Association of Individual Investors (AAII) weekly sentiment survey is off the charts with 70% of AAII members bearish – the highest percentage ever.

INK Research says:

“During the past 90 days, insiders at International Forest Products (IFP.A) have bought 616,900 shares in the public market. The biggest buyer has been board chair Lawrence Sauder who acquired 401,000 shares at prices ranging between $1.25 and $1.70 …. CEO Duncan Davies bought 100,000 shares at prices ranging between $1.77 and $1.92 and CFO John Horning bought 66,800 shares at prices ranging between $1.30 and $1.75. Other insiders who bought shares included officer Stephen Williams (30,500 shares), director John Sullivan (20,000 shares), officer Otto Schulte (7,000 shares) and chief operating officer Sandy Fulton (1,700 shares).”

The more senior and numerous the insiders, the more significant the insider-buying signal, research studies have shown. On this basis IFP.A is sending quite a bullish signal – which is rather amazing considering how dire housing and the economy now look.

On the other hand, the Canadian dollar has plunged from $1.05 (U.S.) to $0.77 (U.S.) in just over a year, making Canadian forest products much cheaper in the U.S. (and other foreign markets). In addition, a massive fiscal and monetary stimulus is being unleashed in the U.S. and around the world, which could produce another upturn in the business cycle at some point.

But could this insider buying be another head fake? In November, for example, an Investing Ideas blog post reported on insider buying at another Canadian forestry company, Canfor, and it is down more than 20% since then. Or will patience be ultimately rewarded?

“Among the factors causing strains,” writes the author, “will be the fallout from unraveling economies and heightened resource constraints, waning U.S. power and global competition for influence … boundaries will shift and alliances will unravel, much like they did when the Communist Party was no longer able to exert its authority over the Union of Soviet Socialist Republics….”

A sign of a good book is that it gives the reader new perspectives and stimulates their thinking – even if they happen to disagree in whole, or part, with the author. Panzner’s latest book easily passes this test.

For example, I was intrigued by the questioning of the notion that foreign diversification is good for portfolios. This popular view might not deliver as well as expected when the world economy is contracting and protectionist measures are multiplying. “The “risks of investing … abroad will be far greater than in the past,” writes Panzner. During de-globalization, “countries will be less concerned about protecting foreigners’ rights ….”

Living in Canada, I got a kick out of reading that one of the few bright spots in the panorama of gloom was Canada. The country “seems to offer great promise as an investment destination. With its relatively stable history and political structure … rich deposits of hydrocarbons and other commodities, access to water, and arable land for farming, the country would seem to have a lot going for it.”

Major themes in the book include:

• a surge in protectionist measures and consequent prolongation of the economic contraction — in unison with other “second-order effects,”

• an extended retrenchment in the free-spending American consumer and firms catering to them,

• ever more perilous government finances that lead to cutbacks to government programs, hikes in tax burdens, forced conversions of investments into government bonds, and a resort in the U.S. to the printing press that may trigger “a hyperinflationary spiral,”

• general loss of confidence in U.S. dollar and other fiat currencies and concomitant rise in preference for precious metals as store of value,

• stocks and bonds will be undesirable asset classes; embrace commodities and resources

• threat of economic blackmail and loss of influence posed by vast reserves of U.S. dollars held by China and other countries

• continued slide in real estate prices, until 2012 at the earliest,

• suburbs to become a wasteland due to water and energy limits,

• rise in civil, regional, and international conflict

When Giants Fall: An Economic Roadmap for the end of the American era by Michael Panzner, John Wiley & Sons, 2009

I agree with those who say investing is as much about character as it is about analytical capability. Character is about having strength in the face of adversity, of being able to hold onto what you believe in while others around you are losing their moorings. It’s about following your own counsel regardless of the crowd view. It’s about having perspectives such as the following:

1. Things are easier to endure if you maintain a healthy balance in lifestyle – proper diet, fresh air, exercise, and other diversions. In Ottawa, a good two-hour skate from one end and back on the canal (world’s longest skating surface) does wonders for clearing the mind. So does a trip away somewhere where the activities are guaranteed to occupy you, like a visit to a cross-country ski resort in the Laurentian Mountains north of Montreal. Needless to say, checking your account and the pulse of financial markets every hour is not part of the prescription.

2. Using mental imagery techniques may help – for example, envisioning what the stock market will look like three to five years from now. Chances are it will be more like the beginning or middle of the last bull phase, from 2002 to 2007. All this anguish will be a faint memory.

3. As mentioned in my column, Why investor’s get burned, realize we are in the phase of the bear market when all the doomsayers look like they were right and are getting major air time in the media. After awhile, they begin to sound plausible. The bottom in the market is four years away says one. Civil unrest in the streets says another. So like Ulysses, you have to “tie yourself to the mast” lest the Sirens’ song lure you into changing direction or jumping into the sea.

4. If the thought of having lost so much money wears on you or even keeps you awake at night, get proactive with making and executing plans for recouping some of the losses via application of your human capital. That is, you may be able to leverage your career training and experience more. Perhaps that might require spending less time on hobbies and more time in income earning pursuits.

5. Keep in mind the history of stocks markets. For example, the greatest rally in the market occurred in the midst of the Great Depression, when the Standard & Poor’s 500 Index rocketed over 100 per cent during the three months from July to September of 1932. The second greatest rally also occurred during the Great Depression, in the 1933, the year after the first greatest rally.

Take the Stay Invested calculator. It demonstrates the value of the buy-and-hold approach by showing the impact of missing some of the best-performing months over a 30-year period (from 1969-1999, using the TSE Total Return Index).

According to the calculator, missing just six of the best months cut returns nearly in half. A $10,000 investment yielded $233,294 at the end of 30 years under buy and hold versus $118,494 for the investor who missed the six best months.

There may be something to be said for buy and hold, but some people would say the Stay Invested calculator is more a marketing tool, a way to keep clients invested so advisors can continue to collect annual management fees of 2% to 3%.

For example, Danielle Park argues in her book Juggling Dynamite that it is somewhat disingenuous to look at only missing the best performing months: if the calculator looked at missing some of the worse-performing months, it would make the market-timing approach look relatively better. There would seem to be better ways to argue the case for either “time in the market” or “timing the market.”

Don Vialoux of the Tech Talk blog thinks the indexes will break below the lows but believes the “chances of a sharp decline on a break below support are relatively low.” That’s because “momentum indicators already are substantially short-term oversold.” For example, the Relative Strength Indicator (RSI) for the S&P 500 and S&P/TSX Composite Indexes are at the 30 level.

On the other hand, Jeff Pierce of the Zentrader blog writes that the decline thus far “seems to be building steam to the downside.” There doesn’t yet appear to be any signs of the panic usually associated with bottoms, in his opinion. For example, the VIX Index remains quite far below its spike of November.

 Charts courtesy of StockCharts.com www.stockcharts.com and Tech Talk Blog