Warren Buffett: Volatility in the Market

Market Volatility

What should you do?

If you own a farm or an apartment, you do not get a quote on them every day or every week.

The value of a business depends on how much in terms of cash it delivers to its owners between now and judgment day and I don't think it changes in 10% in a 2 months period if you are looking at it as a business.

Anything, I mean, anything can happen in the market; that is why don't borrow money against any securities.  Markets don't have to open tomorrow.  You can have extraordinary events.


You can get some of the instruments that people don't understand very well that has a lot of fire-power.

Common stock dividends, an old idea for retirement income, are in vogue again

By Tom PetrunoMarket Beat

April 24, 2010

What will you do for income in retirement?

Draw a pension, if you're very lucky. Collect Social Security. Beyond those two sources of money, most people will have to rely on their savings — bank accounts, investments, home equity or an annuity.

And the challenge for many American retirees won't just be to generate income from their nest egg, but to generate rising income to keep up with inflation.

Looking for a strategy to fill that bill, some investment advisors are turning to a solution that was familiar to Eisenhower-era retirees but increasingly has been lost on generations since then: common stock dividends from big-name companies, which in this era means firms such as Johnson & Johnson, H.J. Heinz Co. and utility PG&E Corp.

"We're pushing this idea with clients now," said Rich Weiss, who as chief investment officer at City National Bank in L.A. oversees about $55 billion. "There's a great case to be made for it."

It isn't difficult to find shares of brand-name consumer products companies with annualized dividend yields of 3% to 3.5%. (A stock's yield is the dividend divided by the current share price.) Yields on utility shares average about 4.4%.

Those dividend returns compare with an interest yield of about 2.6% on a five-year U.S. Treasury note.

Yet the dividend story is likely to be a very hard sell with many people, for eminently understandable reasons.

Retirement is supposed to be about financial stability and reduced investment risk. After the stock market crash of late 2008 and early 2009 — the worst decline since the Great Depression — equities naturally seem dicier than ever to countless Americans.

That's why people have turned to bonds in huge numbers, pumping hundreds of billions of dollars into bond mutual funds over the last 15 months.

Agreed, bonds almost certainly will be a safer place for your money than stocks, particularly over any short time period. But if it's income you're going to need in retirement, bonds aren't the slam-dunk answer they may seem to be.

One reason is that, thanks to the Federal Reserve's cheap-money policies and investors' rush for havens over the last year, interest rates on many types of bonds are well below where they were for most of the last 15 years. So you're starting out with a smaller income reward.

More important is that once you buy a fixed-rate bond (or a bank CD, for that matter), your yield is set until the security matures.

As Kurt Brouwer, principal at financial advisory firm Brouwer & Janachowski in Tiburon, Calif., puts it: "The issuer of a bond is never going to call up and say, ‘We want to pay you more.' "

What about bond mutual funds? Fund investors' income can rise over time if market interest rates go up and the fund buys new bonds paying higher yields. But predicting future interest payments on a fund in a rising rate environment isn't easy because of all the variables involved — including the types of bonds the manager buys, their maturities and whether the fund has more cash leaving than coming in.

And of course you face the risk that higher market interest rates will devalue older, lower-yielding bonds in a fund, depressing the value of your shares.

Dividend-paying stocks, by contrast, can offer what individual bonds can't: the potential for rising income over time, offsetting or more than compensating for inflation.

Healthcare products company Abbott Laboratories, for example, has lifted its dividend 60% since 2005, from an annual payment of $1.10 a share that year to the current annual rate of $1.76. Johnson & Johnson's dividend has risen 71% in the same period; Heinz's payout is up 47%.

All three dividends far outpaced the U.S. consumer price index, which rose about 13% in that period.

But if only the dividend story were that simple, everyone would buy into it. Although your income may rise with a dividend-paying stock, there is the ever-present risk that the share price itself, in the short run or long run, could lose far more than any dividends you'll earn.

The other major risk is that companies can cut their dividends. Some very big firms, including General Electric Co., Macy's Inc. and CBS Corp., did exactly that in 2008 and 2009 as the recession devastated their earnings.

Worse, many banks either slashed or eliminated their payouts altogether. The financial industry had long been one of the favorite sectors of dividend-seeking investors.

So why take a chance on dividend-paying stocks now? Because amid the economy's recovery more companies are boosting their payouts. A total of 284 U.S. firms lifted their dividends in the first quarter, up from 193 in the year-earlier quarter, according to Standard & Poor's. And the number of firms reducing or omitting their dividends plunged to 48 last quarter from a horrid 367 a year earlier.

Also, the Obama administration has signaled that it wants to largely preserve the favored tax treatment of dividends as put in place by President George W. Bush. The Bush tax cuts expire at the end of this year, but Obama supports keeping the dividend tax rate at 15% for couples earning less than $250,000 a year.

For investors who own stocks and bonds outside of tax-deferred retirement accounts, the Bush tax cuts gave dividends a huge advantage over bond interest, which is taxed at ordinary rates.

Josh Peters, who tracks and recommends dividend-paying stocks for investment research firm Morningstar Inc. in Chicago, says his frustration at the moment is that he views most solid dividend-paying stocks as fairly priced, at best — meaning it's hard to find genuine bargains after the market's 13-month surge.

That means the same would be true of the dividend-focused mutual funds and exchange-traded funds that offer an easy way for small investors to invest for dividend returns, albeit without the level of control they'd have by building a portfolio of 15 to 20 individual stocks.

Still, Peters expects that some of his favorite dividend-growth plays, including Waste Management, food-service-industry products distributor Sysco Corp. and payroll-services firm Paychex, will be able to boost their dividends at least 7% a year over the next five years.

He believes that more investors nearing retirement will begin to focus the power of dividend growth in a diversified portfolio.

"I think baby boomers will realize that if they need growth of income they can't just do the bond thing," he said.

tom.petruno@latimes.com

http://www.latimes.com/business/la-fi-petruno-20100424,0,1332567,full.column

Non-convertible Preferred Stocks

1. It is hardly worthwhile to talk about nonconvertible preferred stocks, since their special tax status makes the safe ones much more desirable holdings by corporations – e.g., insurance companies – than by individuals.
2. The poorer-quality ones almost always fluctuate over a wide range, percentage wise, not too differently from common stocks. We can offer no other useful remark about them.

Ref: Intelligent Investor by Benjamin Graham

"Long-term Bond of the Future"

This may be a good place to make a suggestion about the “long term bond of the future.”

1. Why should not the effects of changing interest rates be divided on some practical and equitable basis between the borrowers and the lender?
2. One possibility would be to sell long-term bonds with interest payments that vary with an appropriate index of the going rate.
3. The main results of such an arrangement would be: (1) the investor’s bond would always have a principal value of about 100, if the company maintains its credit rating, but the interest received will vary, say, with the rate offered on conventional new issues; (2) the corporation would have the advantages of long-term debt – being spared problems and costs of frequent renewals of refinancing – but its interest costs would change from year to year.

Over the past decade the bond investor has been confronted by increasingly serious dilemma:

1. Shall he choose complete stability of principal value, but with varying and usually low (short-term) interest rates?
2. Or shall he choose a fixed-interest income, with considerable variations (usually downwards, it seems) in his principal value?

It would be good for most investors if they could compromise between these extremes, and be assured that neither their interest return nor their principal value will fall below a stated minimum over, say, a 20-year period.

1. This could be arranged, without great difficulty, in an appropriate bond contract of a new form.
2. Important note: In effect the U.S. government has done a similar thing in its combination of the original savings-bonds contracts with their extensions at higher interest rates.
3. The suggestion we make here would cover a longer fixed investment period than the savings bonds, and would introduce more flexibility in the interest-rate provisions.

Ref: Intelligent Investor by Benjamin Graham

Price Fluctuations of Convertible Bonds and Convertible Preferred Stocks

1. The price fluctuations of convertible bonds and preferred stocks are the resultant of three different factors: (1) variations in the price of the related common stock, (2) variations in the credit standing of the company, and (3) variations in general interest rates.
2. A good many of the convertible issues have been sold by companies that have credit ratings well below the best. Some of these were badly affected by the financial squeeze in 1970.
3. As a result, convertible issues as a whole have been subjected to triply unsettling influences in recent years, and price variations have been unusually wide.
4. In the typical case, therefore, the investor would delude himself if he expected to find in convertible issues that ideal combination of the safety of a high-grade bond and price protection plus a chance to benefit from an advance in the price of the common.

Ref: Intelligent Investor by Benjamin Graham

Unpredictable Price Movements of Bonds

1. If it is virtually impossible to make worthwhile predictions about the price movements of stocks, it is completely impossible to do so for bonds.
2. In the old days, at least, one could often find a useful clue to the coming end of a bull or bear market by studying the prior action of bonds, but no similar clues were given to a coming change in interest rates and bond prices.
3. Hence the investor must choose between long-term and short-term bond investments on the basis chiefly of his personal preferences.

If he wants to be certain that the market values will not decrease, his best choices are probably U.S. savings bonds, Series E or H.

1. Either issue will give him a 5% yield (after the first year), the Series E for up to 5 ½ years, the Series H for up to ten years, with a guaranteed resale value of cost or better.
2. If the investor wants the 7.5% now available on good long-term corporate bonds, or the 5.3% on tax-free municipals, he must be prepared to see them fluctuate in price.
3. Banks and insurance companies have the privilege of valuing high-rated bonds of this type on the mathematical basis of “amortized cost,” which disregards market prices; it would not be a bad idea for the individual investor to do something similar.

Ref: Intelligent Investor by Benjamin Graham

High-grade Bond Market

Since 1964 record movements in both directions have taken place in the high-grade bond market.

1. Taking “prime municipals” (tax-free) as an example, their yield more than doubled, from 3.2% in January 1965 to 7% in June 1970. Their price index declined, correspondingly, from 110.8 to 67.5.
2. In mid-1970 the yields on high-grade long-term bonds were higher than at any time in the nearly 200 years of this country’s economic history.
3. Twenty-five years earlier, just before our protracted bull market began, bond yields were at their lowest point in history; long-term municipals returned as little as 1%, and industrials gave 2.4% compared with the 4 1/2 to 5% formerly considered “normal.”

Those of us with a long experience on Wall Street had seen Newton’s law of “action and reaction, equal and opposite” work itself out repeatedly in the stock market – the most noteworthy example being the rise in the DJIA from 64 in 1921 to 381 in 1929, followed by a record collapse to 41 in 1932.

1. But this time the widest pendulum swings took place in the usually staid and slow-moving array of high-grade bond prices and yields.
2. Moral: Nothing important on Wall Street can be counted on to occur exactly in the same way as it happened before. This represents the first half of our favorite dictum: “The more it changes, the more it’s the same thing.”

Ref: Intelligent Investor by Benjamin Graham

Fluctuations in Bond Prices

Long-term bond market prices and interest rates changes

1. The investor should be aware that even though safety of its principal and interest may be unquestioned, a long-term bond could vary widely in market price in response to changes in interest rates.
2. Because of their inverse relationship the low yields correspond to the high prices and vice versa.
3. Note that bond prices do not fluctuate in the same (inverse) proportion as the calculated yields, because their fixed maturity value of 100% exerts a moderating influence.
4. However, for very long maturities, prices and yields change at close to the same rate.

Ref: Intelligent Investor by Benjamin Graham