Gala Issue: Biggest Sea Change of Our Lifetime! by Martin D. Weiss, Ph.D.
Dear,
The Fed, the Treasury and all major governments on the planet are throwing the kitchen sink at this debt crisis. But their efforts are being overwhelmed by a monumental sea change — the shift from rising prices to falling prices, from booming asset values to crashing asset values, from wealth creation to wealth destruction, from inflation to deflation.
For my entire lifetime, and probably yours as well, we have been living with inflation — sometimes tame, sometimes rampant — but consistently eroding the purchasing power of our dollar.Inflation pervaded every money decision we made or thought about making, every retirement plan or business model. Inflation was factored into our leases, our employment contracts, our budgets, our investment programs.
Now, all of that is changing; and it's doing so dramatically! Suddenly, the polar opposite of inflation is taking hold in America: Deflation!
Suddenly, prices are plummeting — not just for real estate, but also for automobiles, appliances, clothing and gasoline. From peaks reached just a few months ago to the latest bottoms, the price of oil has plunged 73% ... copper has fallen 66% ... lead and nickel are down 73% ... platinum is down 66% ... and wheat is off 64%.
Even the government's slow-to-change, lagging index of inflation — the CPI — has caved in to deflation, falling by the most since the government first introduced the index in 1946. These are not numbers that denote less inflation. They are hard evidence of outright deflation! This is crucial for you: If you continue investing as you did in inflationary times, you risk losing almost everything. However, if you acknowledge this historic shift and make the right moves now, you'll have the opportunity to build substantial wealth. This inflation-deflation switch is turning the entire world of investments upside down and inside out.
It means you must consider the grave new dangers deflation brings your portfolio and, at the same time, the unique new opportunities deflation gives you to grow your wealth. This past week, during our Deflation Survival Briefing, I covered both topics with Jack Crooks, the only currency expert I'm aware of who, unlike his peers, not only warned unambiguously about deflation but also has a unique way to profit from the deflation. I assume you attended the event online from start to finish. At times, however, the sound may have been unclear, and I apologize. So here's an edited transcript for your convenience. It's a double-length gala issue especially for you, my way of underscoring the vital importance of this sea change.
Deflation Survival Briefingwith Martin D. Weiss and Jack Crooks(Edited Transcript)
Martin Weiss: Jack, the division of labor I've mapped out is this: I will focus on the dangers and protective strategies; you can focus on the opportunities and profit strategies.
Jack Crooks: That makes sense, but I think it's pretty obvious what the dangers are.
Martin: Specifically, you're referring to ...
Jack: Losing money. Losing a lot of money. Deflation means most asset prices go down. When asset prices go down, anyone who owns those assets loses money. It's that simple.
Martin: What most people don't seem to grasp is how much money — the sheer magnitude of the losses. But the Fed just released the numbers, and I want to show them to you. I want you to see for yourself the amazing drama that literally bursts from these pages. On the Web, just go to Flow of Funds, pdf page 113. From this table, I've pulled out the main numbers to walk you through this step by step, because it's probably the most important set of facts you've seen — or will see — for a long time:
The Fed tracks five key sectors that go into household wealth: real estate, corporate equities, mutual fund shares, life insurance and pension fund reserves, plus equity in noncorporate businesses. Now let me show you how the wealth destruction is spreading throughout the U.S. economy. First quarter 2007: Every single wealth sector is still growing, except one — real estate. This $53 billion loss in real estate is a time and place that will go down in history as the great turning point of our era.Second quarter 2007: Another $190 billion in real estate wealth destroyed. Third quarter 2007: Households suffer a whopping $496 billion in losses — nearly 10 times as much as in the first quarter.Fourth quarter 2007: The wealth destruction spreads to nearly all other sectors. Households lose $708 billion in real estate, the most in history. Plus, they lose $377 billion in stocks, $145 billion in mutual funds, $265 billion in their life insurance and pension reserves.First quarter 2008: The carnage deepens. Households lose $911 billion in stocks, $297 billion in mutual funds and $832 billion in insurance and pension fund reserves. Plus, the losses spread to the last major sector, equity in noncorporate businesses. Second quarter 2008: The Bush economic stimulus package kicks in, and it slows down the pace a bit. But the hemorrhaging continues. Not one single sector recovers.Third quarter 2008: Earth-shattering losses across the board, with households losing
...ANOTHER $647 billion in real estate
$922 billion in corporate equities
$523 billion in mutual funds
$653 billion in insurance and pension fund reserves
$128 billion in noncorporate businesses
Grand total: Nearly $2.9 trillion in losses — the worst in recorded history.
Grand total lost over the past year: $7.2 trillion.
Jack: And this is not just a bunch of numbers. It's a hard-nosed reality that almost everyone is up against.
Martin: Absolutely! At the peak of the housing boom, one of our associates had his home appraised at $1.4 million. Three weeks ago, he had it appraised again and it was down around $700,000. That's a 50% decline. And it's not just the high end of the market. In May 2005, another home in our area sold for $175,000; now it's listed at Realtor.com for only $64,000.
Jack: People think that since home values have already fallen so far, they must be near a bottom.
Martin: I don't agree with that view. Most of the price declines we've seen so far merely represent a recognition that the peak prices of the mid-2000s were a fantasy built upon "Frankenstein Financing" — wildly speculative credit terms such as option ARMs and liar loans. The hard-core declines in housing, driven by basic things like recession and unemployment, are just now getting under way.
Jack: How much further do you see home prices falling?
Martin: My personal opinion is that that over half of the declines are still ahead. That applies not only to housing, but also to commercial properties; not only to real estate, but also to stocks and other assets. Consumer prices just began to fall in October. Outright contractions in the economy are just now getting under way. Deflation is still in its early stages. The wealth destruction has a long way to go.
Jack: You call this wealth destruction and I don't deny the validity of that term. But another way to describe it is rampant deflation. Deflation in the value of real estate and other investments, deflation in energy, deflation at the car dealer and deflation at every mall. In each and every sector that you've described, the U.S. dollar buys more.
Martin: That's the positive side of the story. But whatever you call it, these numbers don't lie. You can see with your own eyes that it's massive and that it's spreading throughout the entire economy.
Jack: Martin, all this raises some urgent questions in my mind and probably in the minds of our readers as well. First, can the government offset this massive destruction of wealth with more bailouts, more Fed actions and gigantic economic stimulus packages? Martin: They can buy some time or they can slow down the process temporarily, as they did in the second quarter of 2008, for example. But still, my answer is a flat NO! Not even Washington can print enough money fast enough to halt this deflationary spiral; it's just too huge. And all the printing press money in the world won't do much if it's not lent or spent. Bottom line: No matter which companies Washington bails out, this is a house of cards. It's coming down. And you must get out if its way.
Jack: Still, a lot of people have big expectations for President-elect Obama's stimulus package starting next year.
Martin: The highest estimates for the Obama stimulus package are $1 trillion. But even if it's that big, it's still small in contrast to the wealth destruction we're already seeing. And it's going to take a couple of years before all of that money reaches Americans. By that time, trillions more in wealth could be lost.
Jack: Every economist I read likes to leave some wiggle room for future butt-covering, just in case they turn out to be wrong. But you're not pulling any punches, are you? Why is that?Martin: It's not needed in this situation — because of the sheer enormity and speed of the wealth destruction: $7.2 trillion just through over the past year. In contrast, the Trouble Asset Relief Program (TARP) is $700 billion. So these losses are already ten times more than the entire bailout program.
Let's compare how much is being lost vs. what the government is doing to offset it. Here's the progression we just saw:
$1.5 trillion lost in the fourth quarter of 2007
$2.7 trillion lost in the first quarter of 2008
$630 billion lost in the second quarter of 2008
$2.9 trillion in the third quarter
Now, let me demonstrate why the government's efforts are unable to offset this wealth destruction. Congress has authorized $700 billion for TARP. But the Treasury Department reports that in the fourth quarter, only $330 billion has been committed so far.
Jack: Committed or actually disbursed?
Martin: Committed.
Jack: The ol' check-in-the-mail routine, eh?
Martin: Yes. But let's assume the $330 billion is already at the banks. And let's say that in the first quarter of 2009, they are able to disburse all of the rest. That's still minuscule in comparison to the wealth destruction.
Jack: Meanwhile, the wealth destruction continues.
Martin: Right. We don't know how much. But let's assume the wealth destruction does not decelerate or accelerate. Let's just assume it continues at the same pace.
Here's what it would look like. Moreover, most of the money being funneled to the banks is not reaching consumers and businesses. Instead, it's sitting idle at the banks, to rebuild their capital, to try to offset all the losses they've sustained.
Jack: How much of the TARP money are the banks actually lending out?
Martin: We don't know.
Jack: Isn't this why Congress is so ticked off, trying to find a way to force the banks to lend out the TARP money?
Martin: Yes. But it's a tough sell. The banks are going broke. They're being asked to lend it to borrowers, who they fear will also go broke. So the resistance is great. But even if you assume that Congress can force the Treasury Department to, in turn, force the banks to loan out some fraction of the TARP money, it would still be only a fraction of the total TARP funds.
Jack: A drop in the bucket.
Martin: Absolutely! The huge red areas in this chart represent the tremendous power of deflation. The small black areas represent the impotence of government to offset the deflation.
The power of deflation is hundreds of times larger than the government's ability to counteract it. This is why the U.S. government was not able to prevent deflation in the 1930s. And it's also why the Japanese government was unable to prevent its deflation in the 1990s.
Jack: Still, most people think the government can just print more money at will. They're now talking about a total bill of $8.5 trillion. Your numbers don't seem to account for that.
Martin: Because those bigger numbers are almost entirely guarantees and swaps — not net new money added to the economy. Plus, please bear in mind one more thing: The wealth destruction we've been discussing today does not include the losses by financial institutions, corporations and governments.
Jack: Good point. But let me go to the second major question I get from readers: What's causing this and when will it end?
Martin: What's perpetuating the deflation is excess debts. Look. Debts were usually bearable. As long as people had the income to make their payments — or as long as they could borrow from Peter to pay Paul — they could keep piling up more debt, and life went on. Deflation alone is also not so bad. It makes homes more affordable, college education more accessible, and basic necessities of life cheaper.
Jack: But when you put debts and deflation together
...Martin: That's when things fall apart! That's when you get not only wealth destruction but DEBT destruction.
Jack: And we have evidence of that as well, I presume.
Martin: Yes, undeniable, smoking-gun evidence. For decades, we've almost always seen more debt piled up quarter after quarter, year after year. But then, beginning in the third quarter of 2007, all that changed. For the first time, we saw massive debt liquidation — debt destruction. It started in the commercial paper market, where corporations issue short-term corporate IOUs to borrow in massive amounts: In the third quarter of 2007, instead of growing as it almost always has, commercial paper was being liquidated at a rapid pace. That was the canary in the coal mine.
Jack: And now?
Martin: Now the debt liquidation has spread: In addition to the liquidation of commercial paper, we're seeing massive debt liquidation in mortgages and corporate bonds.Jack: How big?
Martin: The biggest ever in recorded history. Look at mortgages! The Fed reports how much in new mortgages are created each quarter at an annual rate. Ever since you and I were born, all we've even seen is net new growth in mortgages. That's how it was when we were growing up, that's how it was in recent years, and that's what we saw in the third quarter of 2007. See?
Jack: $1,005 billion.
Martin: Yes. Net net, after all mortgage paydowns, new mortgages were added at the rate of $1,005 billion per year. Almost the same in the fourth quarter of 2007. But then look: First quarter 2008 — $539 billion. Second quarter 2008 — new mortgages begin to vanish from the market. Yet, up until this point, we're just talking about a credit crunch.
Jack: In other words, less new credit.
Martin: Yes, and that's already a powerful deflationary force: Most people can't get mortgages. So they can't buy. Since there are few buyers, prices fall. That's when people think: "This is terrible. It couldn't possibly get any worse."
Jack: But it does, doesn't it?
Martin: Dramatically worse: In third quarter of 2008, the volume of mortgages going bad is so big and the volume of new mortgages being created is so small, we have a net decline in mortgages outstanding. For the first time in recorded history, we have a net destruction of debts in this sector. This is far worse than a credit crunch. It is a DEBT COLLAPSE, an unprecedented, unstoppable deflationary force.
The same kind of debt collapse also hits corporate bonds. Third quarter of 2007 — no problem. New bonds are issued at the annual rate of nearly $1,481 billion per year.Fourth quarter of 2007 — big decline, to $821 billion.
Jack: Credit crunch begins to hit.
Martin: Exactly. First and second quarters of 2008 — credit crunch hits even harder. Third quarter of 2008 — debt collapse strikes! It's the biggest net reduction of corporate bonds in recorded history, running at the annual rate of $755 billion (red bar in chart). Again, one of the most powerful deflationary forces of all time!
Jack: So what's the next stage?
Martin: A chain reaction of corporate bankruptcies.
Jack: But it looks like they're going to save companies like General Motors and Chrysler.
Martin: Even if they do, they cannot save hundreds of thousands of smaller and medium-sized companies that are going bankrupt all over the country ... tens of thousands of municipalities and states running out of money ... tens of millions of Americans who have gotten smacked with the trillions in losses I've just showed you in the household sector.
This wealth destruction and debt liquidation is classic; and despite all the government intervention, it is fundamentally very similar to the collapse we saw in 1929 and the early 1930s.
Jack: But many people believe the 1930s Depression was caused by the failure of the federal government to fight the decline. This time, they say, the government is doing precisely the opposite.
Martin: In reality, America's First Great Depression wasn't caused by what the government failed to do to stop it. Rather, it was largely caused by all the wild things the government did do to create the superboom in the Roaring '20s that preceded it. They dished out money to banks like candy. They let banks loan money to brokers without restraint. And they encouraged brokers to hand it off to stock market speculators with 10% margin. But if you want to see what happens when a government intervenes aggressively after a bust, just look at Japan since 1990. Japan lowered interest rates to zero, just like the Fed is doing today. Japan bailed out banks, brokerage firms and insurance companies, much like the Fed is doing here. Japan embarked on massive public works projects, much like President-elect Obama is proposing now.
But it did not end the deflation. And it did not prevent their stock market from making brand-new lows this year. All it did was prolong the agony — now 18 years and counting.
Jack: So precisely how much longer do you think the deflation will continue in the U.S.?
Martin: Nobody knows. But it's clear that this is not a short-term situation that will be resolved in the foreseeable future. It could take years to flush out the bad debts and restore confidence. The key is the debt liquidation. That's the main engine behind the deflation and a major element in vicious cycles that are just beginning to gain momentum. Consider the housing market, for example. The more debts are liquidated, the more prices fall ... and the more prices fall, the more people abandon their homes and mortgages, leading to more debt liquidation. This is what's happening all around the country right now — not only in housing, but also in every asset imaginable. These vicious cycles are like hurricanes striking every city and state in the country. Until they exhaust themselves, the deflation will continue.
Like you said at the outset, deflation is falling asset prices across the board. Not just falling home prices, but falling prices on land and commercial properties. Not just stocks and bonds, and commodities, but also collectibles — art, antiques, stamps and, soon, rare coins as well. There may be some exceptions. But overall, unless you have some very convincing evidence to the contrary, you must assume the value of your assets are going down and going down hard.
Jack: So what's a person to do?
Martin: If you don't need something, seriously consider selling it. Real estate. Stocks. Corporate bonds. Even collectibles if you consider them an investment.Jack: Even if it has already gone down a lot?
Martin: Don't look back at what the price was. Just look ahead to what the price will be after a massive deflation. You don't have to sell everything all at once at any price. Every time the government inspires a rally in the stock market, use that as a selling opportunity. Every time the government stimulates some activity in real estate or in the economy, grab that chance as well.
Jack: Suppose market conditions are so severe, there are no buyers. Then what?
Martin: Then, you can afford to wait for a temporary stabilization or recovery. Markets never go straight down. And even in some of the worst markets, there are ways to sell most assets.
Jack: What about antiques and art?
Martin: For the first time in many years, you're seeing a contraction in major auctions sales. For example, annual sales of contemporary art at Sotheby's and Christie's auctions in New York and London are down 17% in 2008. In the two years before that, they doubled in sales. So that's not a huge decline yet. But it's a sign.You won't get peak prices. However, if you act swiftly, you can still sell. If you wait, you'll get caught. Ditto for stamps and rare coins.
Jack: Gold is holding its value the best compared to the much larger percentages you cited earlier for other commodities. But I believe it's only a matter of time before gold succumbs to the deflation as well. What do you think?
Martin: This is hard for a lot of people to accept, but it's also hard to envision a situation in which gold defies gravity for much longer. It's still a good insurance policy against governments that could run amuck. But I suggest you reduce your holdings to a bare minimum. No matter what, the key is to pile up as much cash as you possibly can. Then put that cash into the safest place you possibly can — short-term Treasury securities. You can buy them from the Treasury Department directly, through their Treasury Direct Program. Or for even better liquidity, I recommend a Treasury-only money market fund. Our favorites are Capital Preservation Fund and the Weiss Treasury Only Money Market Fund. There are many more to choose from and they all provide the same safety.
Jack: Last week, there were some Treasury bills auctioned off at zero yield. Doesn't that discourage you?
Martin: Not in the slightest. As long as your cash is in a safe place, the deeper the deflation, the more your money is worth. My last word: Just make sure you keep it safe!
Jack: Martin, I'm going to assume that's my cue to jump in and take us beyond just safety and protection, so we can talk about turning this deflation into a profit opportunity.
Martin: Yes, please do.
Jack: There is just one thing that always goes up with deflation: The U.S. dollar! By DEFINITION, when the price of investments or goods and services goes down, the value of each dollar goes UP. That's the essence of deflation. And here's the key: When the value of the dollar goes up in the United States, it inevitably goes up abroad as well.
Martin: Please explain that connection more specifically.
Jack: Virtually everything that matters in the global economy — trade, commodities, GDP, debts — is measured in U.S. dollars. The dollar is the world's reserve currency. So just as we see domestically, when your dollar buys more, its value also rises internationally.
Martin: There was a lot of talk about other currencies replacing the dollar as a reserve currency. Jack: Talk, yes; action, no. It never happened. And now, it's going the other way: Your dollars now buy more than two gallons of gas for every one gallon they bought just a few months ago. The dollar now buys three times more oil and copper than just a few months ago. Not just 20% more or 50% more, but three times more! We're seeing the same thing happen against currencies. The dollar is in a massive, long-term uptrend against the euro, the British pound and virtually every currency in the world. Yes, we've witnessed a temporary dollar setback in recent days, but it does nothing to change the big trend.
Martin: It certainly does not change the deflation. But please give us specific reasons why the dollar is rising against currencies in particular.
Jack: There are three big reasons. The main one is that, as I said, the dollar is the global measure of virtually everything. So when there's global deflation, the dollar is the prime beneficiary. Look. We've had decade after decade of inflation and global expansion. During most of that period, the worldwide supply of dollars and dollar-based credit expanded dramatically. And those dollars became the key funding source of bubbles in nearly every major asset class — real estate, stocks, commodities, energy and metals. As the supply of dollars expanded, the dollar lost value. Now we have deflation and global contraction. So now everything is turning the other way. Despite the Fed's efforts to lower interest rates, credit — dollar credit — is drying up all over the world. The overall supply of dollars is contracting. So U.S. dollars are suddenly scarce and their value is going up.
Martin: Still many people in the U.S. don't see that. They think: "If the U.S. economy is in so much trouble, isn't that bad for the dollar?"
Jack: No, that's simply not how it works. A country's currency is never valued based on how well or how poorly that particular economy is doing in isolation. It's always measured against another country's currency. So it is always valued based on how a particular economy is doing relative to another economy. It's not the U.S. dollar vs. some other measure. It's the U.S. dollar versus the euro, the British pound, the Aussie dollar, etc. So the relevant question is never, "How well is the U.S. economy doing?" The question is, "How is the U.S. economy doing compared to the European economy, the U.K. or Australia?" In this environment, it's not a beauty contest. It's a contest of which economy is the least ugly ... which leads me to the second reason the dollar is rising: The U.S. is winning the least ugly contest hands down.
Martin: Please elaborate.Jack: Europe's banks have lent more than $2.7 trillion to the high-risk emerging markets, and those emerging markets are being crushed by deflation. Europe's banks have big exposure to Hungary, and Hungary is collapsing. They have big exposure to the Ukraine and to Russia, which are also collapsing.
Europe's economy is in much worse shape than ours. In Germany, export demand has vanished. So it's just now starting to accelerate downward. Worst of all, the Eurozone's governing bodies are a mess. You've got each member nation making its own monetary policy and each going off on a different course with its economic stimulus plans. For example, the European Central Bank wants to retain some semblance of moderation in its monetary policy. But the leaders in countries like Italy, Greece, Spain, Portugal and Ireland are scared. So they're going to whatever it takes to try to prop up demand, no matter what the central banks says.
Martin: It's adding political chaos to financial chaos.
Jack: Precisely. These are the reasons the euro has been falling and, despite a sharp rally, will likely continue to fall — probably down to parity with the dollar, or lower.
Martin: That's a huge drop — over 30% from these levels. What about the U.K.?
Jack: Worse. Their housing bust is more extreme than ours. Their reliance on revenues from a sinking financial center — London — is far worse than ours. Their consumers have more debt than almost any other developed country.
Martin: And the Australian dollar?
Jack: Solid as long as commodities were going up ... but a disaster with commodities going down! In just the last five months, the Australian dollar has lost 31% of its peak value. Other currencies tied to commodities are also getting killed: The New Zealand dollar is down 39% from its peak; the Brazilian real, 35%; the Canadian dollar, 23%.
Martin: And going forward?
Jack: Deflation means more declines in commodities. And the more commodities fall, the more these commodity currencies plunge. It's that simple.
Martin: You said you had three reasons for the dollar's surge.
Jack: The third reason is the flight to the center. Think of the world currency market as a solar system. The dollar is the sun; the other currencies, the planets. As the system expands, investors migrate from the core currency, the U.S. dollar, to the inner planets — currencies like the euro, the Swiss franc or the pound. And as the system expands even more, they migrate to the next tier of currencies, like the Australian dollar or the Canadian dollar ... and then, still further, to the system's periphery — outer planets like the Brazilian real, the Mexican peso or the South African rand. At each step of the way, they take more risk with less stable economies, use more leverage, go for bigger returns — all fueled by abundant dollar credit.
Martin: OK. What happens when the global economy contracts?
Jack: Precisely the reverse. As the global economy begins to come unglued, they rush back to the center, creating a massive flight back to the U.S. dollar. They have no love affair with the dollar. They just see the peripheral economies going down and they dump those currencies. These are the first risky investments they sell, almost invariably switching back to U.S. dollars. The U.S. economy, despite all its troubles, is still the dominant world economy. Militarily, it's the only remaining superpower. Financially, it's still the world's capital. So it's natural that when investors are running from risk, they rush back to the dollar, bidding up its value.Martin: Is this true across the board, regardless of the currency?
Jack: No. There's one notable exception: The Japanese yen. Japan is the world's second largest economy and also one of the world's largest sources of capital. So when the other currencies go down, a lot of that money goes back to Japan, boosting the yen. But the main point is this: The single most consistent consequence of global deflation is a rising dollar.
Martin: So in the midst of all these bear markets, if you're looking for a big bull market
...Jack: You've found it! It's the U.S. dollar. I think the U.S. dollar is in the early stages of a powerful bull market that could last for years. It's the single cleanest way to make windfall profits from the deflation.
Martin: A year or two ago, you were betting against the dollar, and you were right. Now you're betting on a rising dollar. That's a big change.
Jack: You're darn right it is! It goes hand-in-hand with the big sea change you've so clearly illustrated today.
Martin: Can you explain to our readers how to go about betting on a rising dollar?
Jack: There are several ways. You can place your bets in favor of the dollar, using instruments that are tied to the dollar index. So as the dollar index rises against other currencies, you profit directly. Or you can bet against foreign currencies. Remember, the flip side of a rising dollar is falling currencies. The more those currencies fall against the dollar, the more you make. I prefer betting against the currencies because that lets me choose the weakest of them all.
Martin: What instruments do you use?
Jack: I use a revolutionary investment vehicle called currency ETFs. They're simply exchange-traded funds, just like any other ETFs. The same ease of trading and flexibility, the same low commissions, the same availability through any stock broker. If you buy stocks or any other ETF, you can buy currency ETFs.
Martin: Before we get into this any further, can you give us full disclosure on the risks?
Jack: All investments have risk. If the currency goes the wrong way, you lose money. But the advantage of the currency market is that it's divorced from the stock market. The stock market could be crashing, and it would not interfere with your ability to make large steady profits in the currency market. The U.S. economy could be sinking into a depression, and it would still not interfere with your ability to make nice large steady profits in the currency market. No matter what happens in the global economy or the world's financial markets, there is always at least some major currency that's going up in value.
Martin: Please explain that.
Jack: Currencies are measured against each other. When one is going up, the other is going down, like a seesaw. Therefore, there's always at least one currency going up. There's always a bull market in currencies and, therefore, always a bull market in currency ETFs. I don't recommend currency ETFs for all of your money. But at a time when nearly all other investments are going down, it's a great place to get away from the disasters and find a whole separate world of investment opportunity.
Martin: A world that's far removed from those disasters.
Jack: Exactly. I also think that it's the ideal vehicle for average investors to profit from deflation and a rising dollar.
Martin: Specifically, which ETF do you use to profit from a rising dollar?
Jack: There's an ETF that's tied directly to a rising dollar index. The more the dollar rises, the more money you can make. And there's virtually no limit to how far it can go.
Martin: Before we end today, please name it for us. But of course, it's a two-way street. If the dollar falls, then this ETF would fall in value as well.
Jack: Of course. But there are also ETFs tied to specific falling currencies. When the dollar is rising, it means other currencies are falling. And with these ETFs, the more those currencies fall, the more money you can make. Plus, you can do it with two-for-one leverage.Take the euro, for example. If the euro falls 10%, you stand to make 20%. If the euro falls 20%, you can make 40%. And if you want to be more aggressive and buy them with 50% margin, you can double that leverage. In other words, every 10% decline in the currency gives you a 40% profit opportunity.
Martin: Do you recommend margin?
Jack: I don't think you need it. The currency market offers plenty of profit opportunity without margin.
Martin: Can you give us some specific examples without using margin?
Jack: Sure. Let's say you bet against the British pound last August. In just three months' time, you could have grabbed the equivalent of a 52% annual return on your money. The return on the euro would have been even better. If you could have bought the ETF that's designed to profit from a falling euro, you could have grabbed the equivalent of an 81% total annual return. On the Aussie, you could have made a 68% annual return.
Martin: With the way the stock market is performing and the way yields have fallen, I think most people would be happy with a lot less than that. Jack, if you can help folks make, say, 30% or even 20% per year, and you do so regularly, that would be a great service you provide.
Jack: Plus, we're not talking about speculating on some little-known stock or exoteric bond. When you buy currency ETFs, you're investing in the currency itself — CASH MONEY. You never own a single share of stock or any kind of bond.You're also not affected by financial failures. Since you never buy stocks or bonds in a bank or corporation that could default, currency ETFs help insulate you from the debt crisis. In fact, the debt crisis overseas, which is far more frightening than the debt crisis here, is driving investors into the U.S. dollar, which can actually help investors make more money in their dollar ETFs.
Martin: Since the ETFs are not investing in stocks or bonds, please explain what they are investing in.
Jack: In most cases, interest-bearing money markets. So in those ETFs, on top of the appreciation in the currency we're aiming for, you also earn interest. And with many currency ETFs, the interest yield is higher than what you can make in any U.S. money market.
Martin: Let's say you're wrong about the dollar and the dollar turns down. Then what?
Jack: In 2007, when the dollar was falling, we did very nicely. I have a service dedicated exclusively to currency ETFs, called World Currency Alert. And in it, I can recommend currency ETFs that are available now on every major currency. There's an ETF for the euro, the Japanese yen, the British pound, the Swiss franc, the Australian dollar, the Canadian dollar and more.
Sometimes we'll focus on just a couple of special opportunities; sometimes, when we have a broad movement in the currencies, we'll recommend you diversify among many different ones.
Martin: Does that require a larger investment?
Jack: No. Remember, these are just ETFs, just shares traded on the exchange. So you could buy just one share of each if you wanted to. In other words, there's virtually no investment minimum. With just $1,000, you could buy a whole range of different ETFs across several different currencies.
Martin: What kind of fees are we talking about to buy and sell the currency ETFs?
Jack: You pay a broker commission. But if you use a discount or online broker, your commission costs can be slashed to the bone.
Martin: How does this compare to trading standard ETFs, like those that focus on particular stock sectors?
Jack: I think it's a lot easier and better.
Martin: Why is that?
Jack: Instead of thousands of stocks and stock sectors, you only have to track six major currencies — the euro, British pound, Swiss franc, Japanese yen, Australian dollar and Canadian dollar. Instead of choppy and crazy stock market surges and plunges, currencies tend to give you much bigger, sweeping trends.
Martin: Because ...
Jack: Because once you get these massive macro global trends — like the deflation we talked about — turning them around is like turning a big tanker at sea. They can last for many years. It's like sailing with the Gulf Stream. You just follow the currency current as far as it will take you.
Martin: How would you characterize this current you're riding right now — the deflation pushing the dollar higher?
Jack: I've seen big currency trends before, but nothing quite like this one, nothing as powerful and large. Your numbers bring that home very convincingly, I think.
Martin: Tell us why you think investors should buy your service, and don't be bashful. I think it's safe to say that our readers want to know how to make real money from this deflation, and if you have a unique way to do this, its information they're going to want to pay close attention to. Jack: Actually, you don't need World Currency Alert to invest in currency ETFs. It's very easy to do, and like I said, they're readily available to anyone with a regular stock brokerage account. You buy and sell them just like a stock or any other ETF. You don't need any new accounts. They're extremely liquid. You just aim to buy them low and sell them high, like any other investment.Martin: What would you buy when?
Jack: Whenever you see a setback in the dollar, I would buy the PowerShares Dollar Bull ETF.
Martin: OK. So why should someone buy your service?
Jack: You don't need my service to buy them. You need World Currency Alert to make money in them, to take your profits, and to do it with some degree of consistency.
If your goal is to take no risk whatsoever and keep all your money 100% safe, then buying currency ETFs would be a mistake, because there IS always risk of loss. But if you're concerned about this deflation — or a future return of inflation — then NOT taking this opportunity is the mistake you'd be making, in my view. There's nothing, absolutely nothing standing in your way.
Martin: Except the cost of the service.Jack: No, I don't see that as an obstacle. The cost of World Currency Alert is just $295 per year. If you invested just a couple thousand in one of the trades I just mentioned, you could cover an entire year's cost very easily.
Martin: In terms of timing, when would be a good time for investors to start with your service?Jack: There's no particular time that's better than any other. Right now, we've had a setback in the dollar. So I'm looking to jump in with a new batch of recos, perhaps around the first week of the new year. So you could wait until then. The key timing issue is the price change we're going to put into place: Starting January 1, we're raising the price to $395. So don't wait until then. Because as long as you join before December 31, you save $100. Plus, there are even bigger savings if you join for two years. In fact, I think the two-year membership makes the most sense.
Martin: Because
...Jack: Because, like I said, it offers the biggest savings. And no matter what, if you're not happy, if it doesn't work for you or you just decide to change your mind, no problem — 100% money-back guarantee in the first 90 days; pro-rated refund at any time thereafter.
Martin: That's very fair. Please provide a web link for more info and to order your service.
Jack: It's http://images.moneyandmarkets.com/1195/88357.html
Or you can call 800-393-0189.
Martin: One way to look at this is like a home business to generate extra revenues.
Jack: I agree. All it takes is a couple of minutes each day, and for each minute of your time, you could be looking at a thousand or two in revenue per hour. Just remember, the price goes up January 1, 2009.
Martin: Thank you, Jack. And thank YOU, our readers, for joining us today. Let's talk again soon.Good luck and God bless!Martin
About Money and MarketsFor more information and archived issues, visit http://www.moneyandmarkets.com/Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Tony Sagami, Nilus Mattive, Sean Brodrick, Larry Edelson, Michael Larson and Jack Crooks. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Kristen Adams, Andrea Baumwald, John Burke, Amber Dakar, Michelle Johncke, Dinesh Kalera, Red Morgan, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau and Leslie Underwood.Attention editors and publishers! Money and Markets issues can be republished. Republished issues MUST include attribution of the author(s) and the following short paragraph:This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com/.From time to time, Money and Markets may have information from select third-party advertisers known as "external sponsorships." We cannot guarantee the accuracy of these ads. In addition, these ads do not necessarily express the viewpoints of Money and Markets or its editors. For more information, see our terms and conditions.View our Privacy Policy.Would you like to unsubscribe from our mailing list?To make sure you don't miss our urgent updates, add Weiss Research to your address book. Just follow these simple steps.© 2008 by Weiss Research, Inc. All rights reserved.15430 Endeavour Drive, Jupiter, FL 33478
Tuesday 23 December 2008
Currency ETFs
The ONLY Place Where There’s ALWAYS a Bull Market
Currencies like the dollar, the euro, the British pound, and the Japanese yen are always rising and falling against each other — and when one currency is falling in value, it means by definition that another currency is rising in value.
That means no matter how frightening things get on Wall Street, THERE IS ALWAYS A BULL MARKET TO BE FOUND IN CURRENCIES!
And now, thanks to simple exchange traded funds (ETFs), you can harness the money-making power of currencies with investments that are as easy to buy or sell as a share of stock in IBM or Microsoft! All thanks to new ETFs dedicated to foreign currencies that ANY investor can buy in a regular brokerage account!
And the profits can be substantial ...
* If you bet against the British pound last August — three and one-half months ago — you could have grabbed the equivalent of a 52% annualized gain.
* Also last August, if you bet against the euro, you could have grabbed the equivalent of an 81% annualized gain.
* And at the same time, you could have bet against the Australian dollar and grabbed the equivalent of a 68% annualized gain!
You can’t go back to grab those returns, and neither can I, but imagine what would happen if you could make trades like that over and over again.
I call my currency ETF trading strategy “The Secret of Speed Profits” — and if you’ll give me just two minutes per trading day — a mere ten minutes per week — it can work for you beginning right now.
Some more advantages ...
You don’t have to be an expert investor — everyday people are doing this right now ...
You don’t need to be a millionaire — you can get started with as little as $100 ...
You don’t have to know which stocks will sink or soar — or even dip so much as your pinky toe into the death-defying stock or commodity markets ...
You won’t need any kind of fancy-schmancy commodity or forex trading account; your current brokerage account is just fine ...
You won’t be asked to accept a single risk that makes you uncomfortable — you will always know precisely what you stand to gain or lose to the very penny ...
Put simply ...
All you need is an Internet connectionand the desire to add thousands of dollarsto your portfolio.
Nine HUGE Advantages of Currency ETFs.
Advantage #1 — Currency ETFs are unrelated to any stock or bond market: Currency ETFs invest exclusively in the currency itself — CASH MONEY. You NEVER own a single share of stock or any kind of bond.
Advantage #2 — They shield you from failing institutions: Since you never invest in a stock or bond of a corporation that could default, currency ETFs are far removed from the debt crisis. The debt crisis can even help drive some currencies HIGHER — another OPPORTUNITY to PROFIT from the crisis.
Advantage #3 — Your investment pays you interest: Since most currency ETFs put your money in cash, they often pay interest ON TOP of any profit you earn as the currency rises. In fact, with some currency ETFs, the interest yield is higher than what you can make in a typical money market.
Advantage #4 — You can profit from moves in EVERY major currency: You can buy an ETF devoted to the U.S. dollar, the euro, the British pound, the Swiss Franc, the Japanese yen, the Australian and Canadian dollars and many more.
Plus, because there are also INVERSE currency ETFs, you can also make money when key currencies are falling!
Advantage #5 — Low minimum investment: Because currency ETFs are simply shares traded on the exchange, you can start with just a single share for as little as $25.
So, with a couple of thousand dollars you can buy a whole range of different ETFs across several different currencies. Or you can give our strategy a try with a tiny stake.
Advantage #6 — They’re cheap to own, too: With currency ETFs, you also avoid the big loads (sales charges) that some mutual funds require. When you buy and sell, you do have to pay a broker commission, of course. But if you use a discount or online broker, your commission costs can be slashed to the bone.
Advantage #7 — No trading limits to slow us down: Most mutual fund families discourage frequent switching. If you jump too soon too often, they may send you a warning to restrict your trading. With ETFs, aside from the tiny commissions you pay, switching is not an issue.
Plus, unlike mutual funds, ETFs are priced continually throughout the trading day: You can buy or sell whenever you want to.
Advantage #8 — They’re the soul of simplicity to buy and sell: Since currency ETFs are traded on the exchange much like stocks, you can use stops-loss orders to help protect your profits or cut a loss.
Plus you have the opportunity to buy and sell at better prices by using limits — orders to your broker that specify the minimum or maximum price you’ll accept.
Advantage #9 — NEW: Some currency ETFs are now available with DOUBLE leverage! With these just-released ETFs, your investment moves 20% for every 10% move in the currency. That gives you the potential to transform what could already be a relatively large move in the currency into a GIANT move in your portfolio.
http://images.moneyandmarkets.com/1195/88357.html
Comment: Posting this here for my further exploration and understanding.
Currencies like the dollar, the euro, the British pound, and the Japanese yen are always rising and falling against each other — and when one currency is falling in value, it means by definition that another currency is rising in value.
That means no matter how frightening things get on Wall Street, THERE IS ALWAYS A BULL MARKET TO BE FOUND IN CURRENCIES!
And now, thanks to simple exchange traded funds (ETFs), you can harness the money-making power of currencies with investments that are as easy to buy or sell as a share of stock in IBM or Microsoft! All thanks to new ETFs dedicated to foreign currencies that ANY investor can buy in a regular brokerage account!
And the profits can be substantial ...
* If you bet against the British pound last August — three and one-half months ago — you could have grabbed the equivalent of a 52% annualized gain.
* Also last August, if you bet against the euro, you could have grabbed the equivalent of an 81% annualized gain.
* And at the same time, you could have bet against the Australian dollar and grabbed the equivalent of a 68% annualized gain!
You can’t go back to grab those returns, and neither can I, but imagine what would happen if you could make trades like that over and over again.
I call my currency ETF trading strategy “The Secret of Speed Profits” — and if you’ll give me just two minutes per trading day — a mere ten minutes per week — it can work for you beginning right now.
Some more advantages ...
You don’t have to be an expert investor — everyday people are doing this right now ...
You don’t need to be a millionaire — you can get started with as little as $100 ...
You don’t have to know which stocks will sink or soar — or even dip so much as your pinky toe into the death-defying stock or commodity markets ...
You won’t need any kind of fancy-schmancy commodity or forex trading account; your current brokerage account is just fine ...
You won’t be asked to accept a single risk that makes you uncomfortable — you will always know precisely what you stand to gain or lose to the very penny ...
Put simply ...
All you need is an Internet connectionand the desire to add thousands of dollarsto your portfolio.
Nine HUGE Advantages of Currency ETFs.
Advantage #1 — Currency ETFs are unrelated to any stock or bond market: Currency ETFs invest exclusively in the currency itself — CASH MONEY. You NEVER own a single share of stock or any kind of bond.
Advantage #2 — They shield you from failing institutions: Since you never invest in a stock or bond of a corporation that could default, currency ETFs are far removed from the debt crisis. The debt crisis can even help drive some currencies HIGHER — another OPPORTUNITY to PROFIT from the crisis.
Advantage #3 — Your investment pays you interest: Since most currency ETFs put your money in cash, they often pay interest ON TOP of any profit you earn as the currency rises. In fact, with some currency ETFs, the interest yield is higher than what you can make in a typical money market.
Advantage #4 — You can profit from moves in EVERY major currency: You can buy an ETF devoted to the U.S. dollar, the euro, the British pound, the Swiss Franc, the Japanese yen, the Australian and Canadian dollars and many more.
Plus, because there are also INVERSE currency ETFs, you can also make money when key currencies are falling!
Advantage #5 — Low minimum investment: Because currency ETFs are simply shares traded on the exchange, you can start with just a single share for as little as $25.
So, with a couple of thousand dollars you can buy a whole range of different ETFs across several different currencies. Or you can give our strategy a try with a tiny stake.
Advantage #6 — They’re cheap to own, too: With currency ETFs, you also avoid the big loads (sales charges) that some mutual funds require. When you buy and sell, you do have to pay a broker commission, of course. But if you use a discount or online broker, your commission costs can be slashed to the bone.
Advantage #7 — No trading limits to slow us down: Most mutual fund families discourage frequent switching. If you jump too soon too often, they may send you a warning to restrict your trading. With ETFs, aside from the tiny commissions you pay, switching is not an issue.
Plus, unlike mutual funds, ETFs are priced continually throughout the trading day: You can buy or sell whenever you want to.
Advantage #8 — They’re the soul of simplicity to buy and sell: Since currency ETFs are traded on the exchange much like stocks, you can use stops-loss orders to help protect your profits or cut a loss.
Plus you have the opportunity to buy and sell at better prices by using limits — orders to your broker that specify the minimum or maximum price you’ll accept.
Advantage #9 — NEW: Some currency ETFs are now available with DOUBLE leverage! With these just-released ETFs, your investment moves 20% for every 10% move in the currency. That gives you the potential to transform what could already be a relatively large move in the currency into a GIANT move in your portfolio.
http://images.moneyandmarkets.com/1195/88357.html
Comment: Posting this here for my further exploration and understanding.
The Coming Bubble in U.S. Generics
The Coming Bubble in U.S. Generics
Despite significant positive catalysts, record patent expirations end in 2012.
By Brian Laegeler, CPA 12-22-08 06:00 AM
Despite significant positive catalysts, record patent expirations end in 2012.
By Brian Laegeler, CPA 12-22-08 06:00 AM
No one can deny the significant positive catalysts ahead for the U.S. generic drug industry during Barack Obama's first term. The president-elect favors:
- significant increases in insurance coverage
- increased generic drug utilization in the name of cost containment
- greater Food and Drug Administration resources to speed along generic drug applications
- a new legislative pathway for generic biologics
- other pro-generic industry reforms, such as the reduction of authorized generics and state carve-outs.
In addition, a historic $19 billion of branded drug sales per year are slated to lose patent protection between 2009 and 2012.
Despite this positive outlook, it could be game over in 2013, when the average year's pipeline is halved from $20 billion to $10 billion. Halving the pipeline would cut off oxygen to an industry that, because of price erosion in the existing business, requires new product launches for growth. Under this scenario, a major price war could crush margins and growth.
Although the generic drug industry is typically hypercompetitive, price wars can occur in any year that there isn't enough growth to go around. Small players have to cut prices to an irrational level to gain share, and larger players end up having to match the price of their most desperate competitors.
The last price war that we recall at the manufacturer's level occurred in late 2004 to the first half of 2005. Despite record patent expirations, the industry had matured to the point where smaller players became desperate. In our view, pricing only became rational again because of significant catalysts, such as Medicare Part D in 2006, unprecedented industry consolidation in 2007 and 2008, and a 50% increase in annual patent expirations from 2005 to 2006.
Mitigating Factors
Several factors could mitigate the possibility of a major price war in 2013.
Emerging Markets Exposure
Generic drug markets in Eastern Europe, India, and Latin America have significantly higher growth rates than their U.S. counterpart. Several Western European markets, such as Spain, also remain relatively underpenetrated by generics. Major players, including Teva and Mylan, are less exposed to a U.S. slowdown as only a third of their generics business is U.S.-based. Pure domestic players, such as Watson and Par are at the greatest risk of seeing their margins destroyed. Emerging markets have slowed because of the credit crisis, and the patent situation in Western Europe is similar to the U.S. However, we still view international exposure as a positive in this context.
Generic Biologics
Industry executives argue that generic biologics will usher in a new era of growth based upon the billions of dollars of branded biologics that have yet to face generic competition. Even if a U.S. legislative pathway is approved in 2009, the first major round of generic biologics won't launch until 2013 at the earliest because of a characterization process, limited clinical trials, and application review. Upon approval, they will not take 90% market share upon launch like small molecule generics. Large molecules need to be sold directly to physicians. Plus, we believe big pharma and biopharma could capture at least 50% of this new generics market as they already have the manufacturing, salesforce, and clinical trial expertise.
Cartel Behavior
Perhaps generic drug companies hope to consolidate to the point that pricing will remain rational among a handful of top players. We don't believe the industry will ever be concentrated enough for this to happen. Barriers to entry are too low on a drug-by-drug basis. There are some benefits of being a one-stop shop, but for key drugs, the biggest players will always have to match the craziest price.
Branded Drugs
The largest generic drug companies have a branded drug component, which could counterbalance a price war in U.S. generics. The branded pipelines will have to be evaluated on a company-by-company basis closer to 2012.
Branded Sales Growth
The nominal branded sales at risk in 2013 and beyond will continue to increase during the next five years. However, growth will become harder to come by in this economic environment. The differential between 2012 and 2013 will not change much as both figures continue to increase.
Looking Ahead
We're still at least 24 months in front of the peak of this potential bubble. The size of the peak will depend on the significance of Obama's health-care policy, the effectiveness of industry consolidation, and the rate of recovery of global markets. The timing and depth of any decline will depend on how early the market recognizes the Obama catalysts, how soon the market recognizes the upcoming patent expiration problem, and the extent of which market participants are willing to admit that generic biologics are potentially a major disappointment. Even though we're unsure ourselves what exactly will happen, these are the factors and scenarios we'll consider in the years ahead.
Before you decide on any of the securities mentioned in this article, become a Morningstar.com Premium Member and read our in-depth Analyst Reports on them. As a Premium Member, you'll gain complete access to our investment research--including our Fund Analyst Picks and Highest-Rated Stocks lists--conducted by more than 130 Morningstar analysts, as well as our award-winning suite of portfolio management tools, such as Portfolio X-Ray.
http://news.morningstar.com/articlenet/article.aspx?id=268234
Investing Books
Investing Books for the Stockings
by Vitaliy KatsenelsonThursday, December 18, 2008
provided by Forget about hot stock tips. Stuff a few stockings this holiday season with these books about investing.
In crazy times like today, all one could and actually should ask for is sanity. Yes, sanity--a clear mind free of noise to deal with the insanity that is thrust upon us by a volatile and noise-making machine also known as the stock market. We find ourselves glued to the computer screens or CNBC waiting to find out what the Dow's next tick is going to be. Unfortunately, we are left with only a headache and wasted time. OK, what's next?
More from Forbes.com: • In Pictures: Best Books on Investing• In Pictures: 8 Things You Didn't Know About Warren Buffett • In Pictures: How Would a Billionaire Invest $100,000 Today?
Here is my advice--read. Read books that will bring you sanity, the ones that will snap you back into the shell of investor and out of the sorry shell of nervous observer of the daily stock market melodrama. The following books are excellent choices and will come with plenty of sanity and sage advice.
Selling
I'll start with It's When You Sell That Counts 3rd Ed by Donald Cassidy. Selling is usually as popular as candy the day after Halloween. During secular bull markets selling is frowned upon as buy and hold turns into investing religion. And since sell violates the "hold" covenant of that religion, the investor who buys and sells is labeled as a nonbeliever, or even worse, trader (if you say 'trader' fast enough it sounds like 'traitor').
In secular bull markets, on average, sell decisions are not as rewarding as hold decisions, as market valuations are expanding and even second caliber dogs (stocks) start looking like pedigreed cocker spaniels. Every investor is now a "long-term" investor and sell becomes a four letter word. But being a long-term investor is not about longevity of your hold decisions but it is an attitude. Holding a stock because you bought it is a fallacy; you should only hold a stock if future risk adjusted return warrants it.
Warren Buffett has been mistakenly promoted (though, I'd argue demoted) into the god status of this buy and hold temple. Let's correct this mistake. Warren Buffett became a buy and hold investor when his portfolio and positions became big enough, pushing $60 billion, when selling became a difficult undertaking. In his early career, before "Oracle of Omaha" became his middle name, he was a buy and sell investor. Being on the board of some of his biggest holdings (like Coke and Washington Post) made selling even more difficult.
One doesn't need the benefit of hindsight to know that at 55 times earnings Coke was tremendously overvalued in 1999. Coke, like the majority of his top public holdings (WPO, PG, JNJ and many others), did not go anywhere in a decade.
I dare you to take a look at his top public holdings and tell me if he would have done a lot better if he sold them when they became fully valued (or slightly overvalued). In most cases it would have been a decade ago.
Emotions pour from different directions when we face a sell decision: If it is a losing investment we want to wait to break even. This is the wrong attitude. Our purchase prices and sell decision should not be related (the only exception I can think of is tax selling). Or when it comes to selling a winner--we want to sell only at the top. Again this is the wrong attitude: the top is only apparent in hindsight, when it is usually too late.
We should sell the stock when it reaches our price or valuation target, determined at the time of purchase. We (our emotions and false goals to be exact) are our biggest enemy when it comes to investing and especially selling. This wonderful book has been written to fix this. Its objective is to recalibrate your mind and free you from imprisonment of past decisions, break you free from the buy and hold state of mind and turn you into a buy and sell investor.
OK, this is a bit of a long introduction to this book, but this is a terrific and a very important book. A proper sell discipline will decide between great or mediocre returns for even the best-crafted buy decisions. Pros may want to skip a few chapters, but it is an important read for everyone, especially in today's environment.
Behave and Think Like an Investor
These books should help you to think like an investor, forcing you to think beyond stock tickers and focus on what is under the hood--the businesses and the people who run them.
The first one is The Essays of Warren Buffett: Lessons for Corporate America. It's a compilation of Warren Buffett's letters to shareholders from annual reports dating back to the 1970s. Before this book came out (or at least before I was aware of its existence) I had my students read Buffett's annual reports, which as you may expect were very repetitious. His wisdom doesn't vary that much from year to year. This book organizes main concepts and removes annoying redundancy.
Another book is The Entrepreneurial Investor: The Art, Science, and Business of Value Investing, written by my friends at West Coast Asset Management. It accomplishes many objectives of Buffett's essays plus has plenty of cultural references, humor and common sense. All of these things make it a fun and enjoyable read. I made this book suggested reading in my graduate investment class.
The Super Analysts by Andrew Leeming is a book I think few people have heard of. The author interviews successful investors (not academics), and they discuss their approach to investing and analysis of common stocks and some specific industries.
You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits by Joel Greenblatt is one of those books that should be read more than once. Joel shares very unique approaches of how to find undervalued stocks. On top of being a very good investor, he has a healthy sense of humor.
Joel also has written The Little Book That Beats the Market (Little Books. Big Profits). I plan to read this book with my son when he gets older as it is a great introduction to investing. At the end of the book Joel offers a "magic formula," a screen that has beaten the market over a long period of time.
The magic screen is very simple: buy low price to earnings stocks that have high return on capital. Low P/E is an indication of cheapness, high return on capital is an indication of competitive advantage (at least in the past) and possibility to grow earnings at high rates. Here is the book's Web site, which provides a weekly list of stocks that score high on both measures.
Behavioral Investing
The right temperament is crucial in investing. Being a critical thinker and knowing how to value stocks is important, but it is all a waste if your emotions get the better of you. The following books will help you to recognize the shortcomings of your hard-wiring and help you to devise strategies to deal with it.
Psychology of Investing (3rd Edition) by John R. Nofsinger is short and to the point. You'll become an expert on behavioral investing in about an hour. Well, not quite, but close.
Why Smart People Make Big Money Mistakes And How To Correct Them: Lessons From The New Science of Behavioral Economics by Gary Belsky and Thomas Gilovich is a fun and easy read. It also addresses how shortcomings in our wiring impact other parts of money decisions, like buying cars and stereos.
Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich by Jason Zweig is another selection. I have to admit that the first two books cover many topics in this book (though offers new angles and insights) and are likely to be a more exciting reads, but Chapter 10 is what makes this book a must read--it addresses happiness--yes happiness.
Though as most of us know money doesn't buy happiness (unless you are starving or living on the street), money spent on acquisitions--things--brings a bust of happiness that quickly fades away. Think of your level of happiness when you bought the car of your dreams. Money spent on experiences--being--brings a higher utility of happiness. Recollecting experience brings happiness. I plan to re-read this chapter at least a couple of times a year. Zweig also provides a list of things you can do that will make you happy, and none of them require you to spend a penny, which is a big positive in today's economy.
Economics
Politicians, God rest their souls, always try to appeal to the lowest common denominator. They try to "protect" us from evil doers by insisting on minimum wage laws or rent controls, or threatening windfall taxes on oil companies. They sound like heroes fighting for the little guy against the evil doers. However, all they are doing is feeding on the economic illiteracy of the Average Joe.
This is why the following two books should be a required reading in high schools and colleges: Basic Economics 3rd Ed: A Common Sense Guide to the Economy by Thomas Sowell and A World of Wealth: How Capitalism Turns Profits into Progress by Thomas G. Donlan.
You may think Alan Greenspan has had a hand in today's crisis. I know I do. He took interest rates down to incredibly low levels and kept them there for too long, causing the real estate bubble. He also did not think Wall Street needed regulation. But this doesn't make his book, Age of Turbulence, any less of an excellent read. It is not written in Fed-speak. It seems that Sir Alan, after he left the Fed, learned how to use English in a very clear and engaging way. This is not just another biography, either. The book goes far beyond that. It covers the workings of the Fed, lessons on macro economy and history and perspective on American politics from an insider who served under or worked with the last eight presidents.
Stock Market History
I've really enjoyed reading Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns and Long Term Investment Strategies by Jeremy Siegel, but it took me a while to recognize how dangerous this book is.
It is well written and provides a very good overview of the performance of different asset classes over last two centuries. But the book needs a different title, maybe something like Stocks for the Really, Really… Really, Long Run. This way, it would not lure investors into false sense of security when it comes to stocks. It preaches that stocks (stock market as a whole) are always a buy, no matter what valuations as they do better than other asset classes in the long-run, and that a 7% real rate of return is a birthright for stock investors no matter if the stock market is extremely cheap or ridiculously expensive.
This is very true if your time horizon is 30 years or you plan to live forever. It is also true if you can tolerate seeing your portfolio go nowhere for a decade or longer. Unfortunately, most of us don't have this time horizon. We need to send kids to school, pay for weddings, boats, etc. I don't know anyone who has the patience to see their portfolio of stocks do nothing for decades.
This is why this book should only be read with the following antidote: Unexpected Returns: Understanding Secular Stock Market Cycles, which is a truly terrific book by Ed Easterling.
Unlike Siegel, Easterling shows that despite stocks being a great investment for the (really, really) long-run, they have periods when their returns are unspectacular. Ed calls these periods bear markets. I call them range-bound markets, which is a difference in just semantics. Those bear (range-bound) markets take place after secular bull markets.
The Appropriate Way to Look at Risk
The following two books, Fooled by Randomness and Black Swan are written by Nassim Taleb. These books address risk and rare events (the Black Swans).
Fooled by Randomness is my favorite nonfiction book, period. I've read it at least five times. This book turns the way we are taught to look at risk upside down. Nassim rebels against the current establishment of finance that measures risk with elegant formulas that receive Nobel Prizes but lack common sense. Any model that solely focuses on past observations and dismisses outcomes that lie outside of what happened in the past is worthless and more importantly dangerous.
One way of understanding how randomness works is by studying alternative historical paths. This means more than just focusing on what took place in the past--the definite (since it already happened), observed history, but one that beforehand was actually still just one of many possible random outcomes. One should focus on what could have taken place, what alternative paths may have existed. This allows us to think creatively about what could have happened and with that added insight then to predict and prepare for what may happen in the future.
More from Yahoo! Finance: • In Lean Times, Online Coupons Catching On• Million-Dollar Giveaways: A Trend of the Times• Stave Off the Ever-Circling Credit Crunch
Visit the Banking & Budgeting Center
Let's take the current crisis: Wall Street and rating agencies dismissed a possibility that housing prices may decline nationwide--this hadn't happened since World War II--well, then it will not happen in the future. Therefore, Wall Street took sub-prime (risky) mortgages originated in different parts of the country, put them together in mortgaged backed securities and--voila!--the risk had been diversified away. Junk was turned to gold. Since rating agencies used the same underlying assumption--housing never declines nationwide--they announced to the world that the junk is AAA and should be bought in truck loads and they were. We know how this story played out.
The Black Swan is a follow up to Fooled by Randomness. Nassim takes a lot of the concepts discussed in Fooled by Randomness and explains them in greater detail, providing new unexpected insights. I have to warn you that The Black Swan is not easy. This book has more insight per page than most, but it is not a beach read.
Books for the Soul
What would you do and what would you share with others if you only had months to live? This is the theme of the following two books: Tuesdays with Morrie: An Old Man, a Young Man, and Life's Greatest Lesson by Mitch Albom and The Last Lecture by Randy Pausch and Jeffrey Zaslow. In both cases terminally ill teachers share their life lessons with readers.
Another book I'll add to this category is The Snowball: Warren Buffett and the Business of Life by Alice Schroeder. This is an authorized biography of Warren Buffett. I am not sure this is the best book to read if you want to learn to invest like Mr. Buffett, but it gives a very different and interesting view into his life.
There are many great lessons we can learn from Mr. Buffett that go far beyond investing, like about honesty and treasuring one's reputation. But I thought this book was important for a very different reason in that it shows that Warren Buffett is not a perfect human being and we can learn from the maestro but in a different way: by not repeating his mistakes. He achieved his unparalleled success in his business life at the expense of his personal life, unfortunately.
Especially in today's environment I find myself wanting to work 24/7 (and I probably do). This is truly a stock picker's market. There are a lot of cheap stocks, but a lot of them are deceptively cheap and there are so many risks lurking from so many directions that semi normal working hours are not enough.
I bring my laptop home, read The Wall Street Journal at the dinner table, and my work life starts pushing out my personal life. This book made me realize that no professional success is worth regretting 20 years down the road that you didn't spend enough time with your kids. Unfortunately, Buffett has that regret.
Copyrighted, Forbes.com. All rights reserved.
http://finance.yahoo.com/banking-budgeting/article/106332/Investing-Books-For-The-Stockings
by Vitaliy KatsenelsonThursday, December 18, 2008
provided by Forget about hot stock tips. Stuff a few stockings this holiday season with these books about investing.
In crazy times like today, all one could and actually should ask for is sanity. Yes, sanity--a clear mind free of noise to deal with the insanity that is thrust upon us by a volatile and noise-making machine also known as the stock market. We find ourselves glued to the computer screens or CNBC waiting to find out what the Dow's next tick is going to be. Unfortunately, we are left with only a headache and wasted time. OK, what's next?
More from Forbes.com: • In Pictures: Best Books on Investing• In Pictures: 8 Things You Didn't Know About Warren Buffett • In Pictures: How Would a Billionaire Invest $100,000 Today?
Here is my advice--read. Read books that will bring you sanity, the ones that will snap you back into the shell of investor and out of the sorry shell of nervous observer of the daily stock market melodrama. The following books are excellent choices and will come with plenty of sanity and sage advice.
Selling
I'll start with It's When You Sell That Counts 3rd Ed by Donald Cassidy. Selling is usually as popular as candy the day after Halloween. During secular bull markets selling is frowned upon as buy and hold turns into investing religion. And since sell violates the "hold" covenant of that religion, the investor who buys and sells is labeled as a nonbeliever, or even worse, trader (if you say 'trader' fast enough it sounds like 'traitor').
In secular bull markets, on average, sell decisions are not as rewarding as hold decisions, as market valuations are expanding and even second caliber dogs (stocks) start looking like pedigreed cocker spaniels. Every investor is now a "long-term" investor and sell becomes a four letter word. But being a long-term investor is not about longevity of your hold decisions but it is an attitude. Holding a stock because you bought it is a fallacy; you should only hold a stock if future risk adjusted return warrants it.
Warren Buffett has been mistakenly promoted (though, I'd argue demoted) into the god status of this buy and hold temple. Let's correct this mistake. Warren Buffett became a buy and hold investor when his portfolio and positions became big enough, pushing $60 billion, when selling became a difficult undertaking. In his early career, before "Oracle of Omaha" became his middle name, he was a buy and sell investor. Being on the board of some of his biggest holdings (like Coke and Washington Post) made selling even more difficult.
One doesn't need the benefit of hindsight to know that at 55 times earnings Coke was tremendously overvalued in 1999. Coke, like the majority of his top public holdings (WPO, PG, JNJ and many others), did not go anywhere in a decade.
I dare you to take a look at his top public holdings and tell me if he would have done a lot better if he sold them when they became fully valued (or slightly overvalued). In most cases it would have been a decade ago.
Emotions pour from different directions when we face a sell decision: If it is a losing investment we want to wait to break even. This is the wrong attitude. Our purchase prices and sell decision should not be related (the only exception I can think of is tax selling). Or when it comes to selling a winner--we want to sell only at the top. Again this is the wrong attitude: the top is only apparent in hindsight, when it is usually too late.
We should sell the stock when it reaches our price or valuation target, determined at the time of purchase. We (our emotions and false goals to be exact) are our biggest enemy when it comes to investing and especially selling. This wonderful book has been written to fix this. Its objective is to recalibrate your mind and free you from imprisonment of past decisions, break you free from the buy and hold state of mind and turn you into a buy and sell investor.
OK, this is a bit of a long introduction to this book, but this is a terrific and a very important book. A proper sell discipline will decide between great or mediocre returns for even the best-crafted buy decisions. Pros may want to skip a few chapters, but it is an important read for everyone, especially in today's environment.
Behave and Think Like an Investor
These books should help you to think like an investor, forcing you to think beyond stock tickers and focus on what is under the hood--the businesses and the people who run them.
The first one is The Essays of Warren Buffett: Lessons for Corporate America. It's a compilation of Warren Buffett's letters to shareholders from annual reports dating back to the 1970s. Before this book came out (or at least before I was aware of its existence) I had my students read Buffett's annual reports, which as you may expect were very repetitious. His wisdom doesn't vary that much from year to year. This book organizes main concepts and removes annoying redundancy.
Another book is The Entrepreneurial Investor: The Art, Science, and Business of Value Investing, written by my friends at West Coast Asset Management. It accomplishes many objectives of Buffett's essays plus has plenty of cultural references, humor and common sense. All of these things make it a fun and enjoyable read. I made this book suggested reading in my graduate investment class.
The Super Analysts by Andrew Leeming is a book I think few people have heard of. The author interviews successful investors (not academics), and they discuss their approach to investing and analysis of common stocks and some specific industries.
You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits by Joel Greenblatt is one of those books that should be read more than once. Joel shares very unique approaches of how to find undervalued stocks. On top of being a very good investor, he has a healthy sense of humor.
Joel also has written The Little Book That Beats the Market (Little Books. Big Profits). I plan to read this book with my son when he gets older as it is a great introduction to investing. At the end of the book Joel offers a "magic formula," a screen that has beaten the market over a long period of time.
The magic screen is very simple: buy low price to earnings stocks that have high return on capital. Low P/E is an indication of cheapness, high return on capital is an indication of competitive advantage (at least in the past) and possibility to grow earnings at high rates. Here is the book's Web site, which provides a weekly list of stocks that score high on both measures.
Behavioral Investing
The right temperament is crucial in investing. Being a critical thinker and knowing how to value stocks is important, but it is all a waste if your emotions get the better of you. The following books will help you to recognize the shortcomings of your hard-wiring and help you to devise strategies to deal with it.
Psychology of Investing (3rd Edition) by John R. Nofsinger is short and to the point. You'll become an expert on behavioral investing in about an hour. Well, not quite, but close.
Why Smart People Make Big Money Mistakes And How To Correct Them: Lessons From The New Science of Behavioral Economics by Gary Belsky and Thomas Gilovich is a fun and easy read. It also addresses how shortcomings in our wiring impact other parts of money decisions, like buying cars and stereos.
Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich by Jason Zweig is another selection. I have to admit that the first two books cover many topics in this book (though offers new angles and insights) and are likely to be a more exciting reads, but Chapter 10 is what makes this book a must read--it addresses happiness--yes happiness.
Though as most of us know money doesn't buy happiness (unless you are starving or living on the street), money spent on acquisitions--things--brings a bust of happiness that quickly fades away. Think of your level of happiness when you bought the car of your dreams. Money spent on experiences--being--brings a higher utility of happiness. Recollecting experience brings happiness. I plan to re-read this chapter at least a couple of times a year. Zweig also provides a list of things you can do that will make you happy, and none of them require you to spend a penny, which is a big positive in today's economy.
Economics
Politicians, God rest their souls, always try to appeal to the lowest common denominator. They try to "protect" us from evil doers by insisting on minimum wage laws or rent controls, or threatening windfall taxes on oil companies. They sound like heroes fighting for the little guy against the evil doers. However, all they are doing is feeding on the economic illiteracy of the Average Joe.
This is why the following two books should be a required reading in high schools and colleges: Basic Economics 3rd Ed: A Common Sense Guide to the Economy by Thomas Sowell and A World of Wealth: How Capitalism Turns Profits into Progress by Thomas G. Donlan.
You may think Alan Greenspan has had a hand in today's crisis. I know I do. He took interest rates down to incredibly low levels and kept them there for too long, causing the real estate bubble. He also did not think Wall Street needed regulation. But this doesn't make his book, Age of Turbulence, any less of an excellent read. It is not written in Fed-speak. It seems that Sir Alan, after he left the Fed, learned how to use English in a very clear and engaging way. This is not just another biography, either. The book goes far beyond that. It covers the workings of the Fed, lessons on macro economy and history and perspective on American politics from an insider who served under or worked with the last eight presidents.
Stock Market History
I've really enjoyed reading Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns and Long Term Investment Strategies by Jeremy Siegel, but it took me a while to recognize how dangerous this book is.
It is well written and provides a very good overview of the performance of different asset classes over last two centuries. But the book needs a different title, maybe something like Stocks for the Really, Really… Really, Long Run. This way, it would not lure investors into false sense of security when it comes to stocks. It preaches that stocks (stock market as a whole) are always a buy, no matter what valuations as they do better than other asset classes in the long-run, and that a 7% real rate of return is a birthright for stock investors no matter if the stock market is extremely cheap or ridiculously expensive.
This is very true if your time horizon is 30 years or you plan to live forever. It is also true if you can tolerate seeing your portfolio go nowhere for a decade or longer. Unfortunately, most of us don't have this time horizon. We need to send kids to school, pay for weddings, boats, etc. I don't know anyone who has the patience to see their portfolio of stocks do nothing for decades.
This is why this book should only be read with the following antidote: Unexpected Returns: Understanding Secular Stock Market Cycles, which is a truly terrific book by Ed Easterling.
Unlike Siegel, Easterling shows that despite stocks being a great investment for the (really, really) long-run, they have periods when their returns are unspectacular. Ed calls these periods bear markets. I call them range-bound markets, which is a difference in just semantics. Those bear (range-bound) markets take place after secular bull markets.
The Appropriate Way to Look at Risk
The following two books, Fooled by Randomness and Black Swan are written by Nassim Taleb. These books address risk and rare events (the Black Swans).
Fooled by Randomness is my favorite nonfiction book, period. I've read it at least five times. This book turns the way we are taught to look at risk upside down. Nassim rebels against the current establishment of finance that measures risk with elegant formulas that receive Nobel Prizes but lack common sense. Any model that solely focuses on past observations and dismisses outcomes that lie outside of what happened in the past is worthless and more importantly dangerous.
One way of understanding how randomness works is by studying alternative historical paths. This means more than just focusing on what took place in the past--the definite (since it already happened), observed history, but one that beforehand was actually still just one of many possible random outcomes. One should focus on what could have taken place, what alternative paths may have existed. This allows us to think creatively about what could have happened and with that added insight then to predict and prepare for what may happen in the future.
More from Yahoo! Finance: • In Lean Times, Online Coupons Catching On• Million-Dollar Giveaways: A Trend of the Times• Stave Off the Ever-Circling Credit Crunch
Visit the Banking & Budgeting Center
Let's take the current crisis: Wall Street and rating agencies dismissed a possibility that housing prices may decline nationwide--this hadn't happened since World War II--well, then it will not happen in the future. Therefore, Wall Street took sub-prime (risky) mortgages originated in different parts of the country, put them together in mortgaged backed securities and--voila!--the risk had been diversified away. Junk was turned to gold. Since rating agencies used the same underlying assumption--housing never declines nationwide--they announced to the world that the junk is AAA and should be bought in truck loads and they were. We know how this story played out.
The Black Swan is a follow up to Fooled by Randomness. Nassim takes a lot of the concepts discussed in Fooled by Randomness and explains them in greater detail, providing new unexpected insights. I have to warn you that The Black Swan is not easy. This book has more insight per page than most, but it is not a beach read.
Books for the Soul
What would you do and what would you share with others if you only had months to live? This is the theme of the following two books: Tuesdays with Morrie: An Old Man, a Young Man, and Life's Greatest Lesson by Mitch Albom and The Last Lecture by Randy Pausch and Jeffrey Zaslow. In both cases terminally ill teachers share their life lessons with readers.
Another book I'll add to this category is The Snowball: Warren Buffett and the Business of Life by Alice Schroeder. This is an authorized biography of Warren Buffett. I am not sure this is the best book to read if you want to learn to invest like Mr. Buffett, but it gives a very different and interesting view into his life.
There are many great lessons we can learn from Mr. Buffett that go far beyond investing, like about honesty and treasuring one's reputation. But I thought this book was important for a very different reason in that it shows that Warren Buffett is not a perfect human being and we can learn from the maestro but in a different way: by not repeating his mistakes. He achieved his unparalleled success in his business life at the expense of his personal life, unfortunately.
Especially in today's environment I find myself wanting to work 24/7 (and I probably do). This is truly a stock picker's market. There are a lot of cheap stocks, but a lot of them are deceptively cheap and there are so many risks lurking from so many directions that semi normal working hours are not enough.
I bring my laptop home, read The Wall Street Journal at the dinner table, and my work life starts pushing out my personal life. This book made me realize that no professional success is worth regretting 20 years down the road that you didn't spend enough time with your kids. Unfortunately, Buffett has that regret.
Copyrighted, Forbes.com. All rights reserved.
http://finance.yahoo.com/banking-budgeting/article/106332/Investing-Books-For-The-Stockings
**Averaging Down: Good Idea Or Big Mistake?
Investopedia
Averaging Down: Good Idea Or Big Mistake?
Friday December 19, 12:38 pm ET Elvis Picardo
The strategy of "averaging down", as the term implies, involves investing additional amounts in a financial instrument or asset if it declines significantly in price after the original investment is made. It's true that this action brings down the average cost of the instrument or asset, but will it lead to great returns or just to a larger share of a losing investment? Read on to find out.
Conflicting Opinions
There is radical difference of opinion among investors and traders about the viability of the averaging down strategy. Proponents of the strategy view averaging down as a cost-effective approach to wealth accumulation; opponents view it as a recipe for disaster.
The strategy is often favored by investors who have a long-term investment horizon and a contrarian approach to investing. A contrarian approach refers to a style of investing that is against, or contrary, to the prevailing investment trend.
For example, suppose that a long-term investor holds Widget Co. stock in his or her portfolio and believes that the outlook for Widget Co. is positive. This investor may be inclined to view a sharp decline in the stock as a buying opportunity, and probably also has the contrarian view that others are being unduly pessimistic about Widget Co.'s long-term prospects. Such investors justify their bargain-hunting by viewing a stock that has declined in price as being available at a discount to its intrinsic or fundamental value. "If you liked the stock at $50, you should love it at $40" is a mantra often quoted by these investors.
On the other side of the coin are the investors and traders who generally have shorter term investment horizons and view a stock decline as a portent of things to come. These investors are also likely to espouse trading in the direction of the prevailing trend, rather than against it. They may view buying into a stock decline as akin to trying to "catch a falling knife." Such investors and traders are more likely to rely on technical indicators, such as price momentum, to justify their investing actions. Using the example of Widget Co., a short-term trader who initially bought the stock at $50 may have a stop-loss on this trade at $45. If the stock trades below $45, the trader will sell the position in Widget Co. and crystallize the loss. Short-term traders generally do not believe in averaging their positions down, as they see this as throwing good money after bad.
Advantages of Averaging Down
The main advantage of averaging down is that an investor can bring down the average cost of a stock holding quite substantially. Assuming the stock turns around, this ensures a lower breakeven point for the stock position, and higher gains in dollar terms than would have been the case if the position was not averaged down.
In the previous example of Widget Co., by averaging down through the purchase of an additional 100 shares at $40, the investor brings down the breakeven point (or average price) of the position to $45. If Widget Co. stock trades at $49 in another six months, the investor now has a potential gain of $800 (despite the fact that the stock is still trading below the initial entry price of $50).
If Widget Co. continues to rise and advances to $55, the potential gains would be $2,000. By averaging down, the investor has effectively "doubled up" the Widget Co. position. Had the investor not averaged down when the stock declined to $40, the potential gain on the position (when the stock is at $55) would amount to only $500.
Disadvantages
Averaging down or doubling up works well when the stock eventually rebounds because it has the effect of magnifying gains, but if the stock continues to decline, losses are also magnified. In such cases, the investor may rue the decision to average down rather than either exiting the position or not adding to the initial holding.
Investors must therefore take the utmost care to correctly assess the risk profile of the stock being averaged down. While this is no easy feat at the best of times, it becomes an even more difficult task during frenzied bear markets such as that of 2008, when household names such as Fannie Mae, Freddie Mac, AIG and Lehman Brothers lost most of their market capitalization in a matter of months.
Another drawback of averaging down is that it may result in a higher-than-desired weighting of a stock or sector in an investment portfolio. As an example, consider the case of an investor who had a 25% weighting of U.S. bank stocks in a portfolio at the beginning of 2008. If the investor averaged down his or her bank holdings after the precipitous decline in most bank stocks that year so that these stocks made up 35% of the investor's total portfolio. This proportion may represent a higher degree of exposure to bank stocks than that desired, putting the investor at much higher risk.
Practical Applications
Some of the world's most astute investors, including Warren Buffett, have successfully used the averaging down strategy over the years. While the pockets of the average investor are nowhere near as deep as deep as Buffett's, averaging down can still be a viable strategy, albeit with a few caveats:
Averaging down should be done on a selective basis for specific stocks, rather than as a catch-all strategy for every stock in a portfolio. This strategy is best restricted to high-quality, blue-chip stocks where the risk of corporate bankruptcy is low. Blue chips that satisfy stringent criteria - which include a long-term track record, strong competitive position, very low or no debt, stable business, solid cash flows, and sound management - may be suitable candidates for averaging down.
Before averaging down a position, the company's fundamentals should be thoroughly assessed. The investor should ascertain whether a significant decline in a stock is only a temporary phenomenon, or a symptom of a deeper malaise. At a minimum, factors that need to be assessed are the company's competitive position, long-term earnings outlook, business stability and capital structure.
The strategy may be particularly suited to times when there is an inordinate amount of fear and panic in the markets, because panic liquidation may result in high-quality stocks being available at compelling valuations. For example, some of the biggest technology stocks were trading at bargain-basement levels in the summer of 2002, while U.S. and international bank stocks were on sale in the second half of 2008. The key, of course, is exercising prudent judgment in picking the stocks that are best positioned to survive the shakeout.
Conclusion
Averaging down is a viable investment strategy for stocks, mutual funds and exchange-traded funds. However, due care must be exercised in deciding which positions to average down. The strategy is best restricted to blue chips that satisfy stringent selection criteria such as a long-term track record, minimal debt and solid cash flows.
http://biz.yahoo.com/investopedia/081219/4101.html
Averaging Down: Good Idea Or Big Mistake?
Friday December 19, 12:38 pm ET Elvis Picardo
The strategy of "averaging down", as the term implies, involves investing additional amounts in a financial instrument or asset if it declines significantly in price after the original investment is made. It's true that this action brings down the average cost of the instrument or asset, but will it lead to great returns or just to a larger share of a losing investment? Read on to find out.
Conflicting Opinions
There is radical difference of opinion among investors and traders about the viability of the averaging down strategy. Proponents of the strategy view averaging down as a cost-effective approach to wealth accumulation; opponents view it as a recipe for disaster.
The strategy is often favored by investors who have a long-term investment horizon and a contrarian approach to investing. A contrarian approach refers to a style of investing that is against, or contrary, to the prevailing investment trend.
For example, suppose that a long-term investor holds Widget Co. stock in his or her portfolio and believes that the outlook for Widget Co. is positive. This investor may be inclined to view a sharp decline in the stock as a buying opportunity, and probably also has the contrarian view that others are being unduly pessimistic about Widget Co.'s long-term prospects. Such investors justify their bargain-hunting by viewing a stock that has declined in price as being available at a discount to its intrinsic or fundamental value. "If you liked the stock at $50, you should love it at $40" is a mantra often quoted by these investors.
On the other side of the coin are the investors and traders who generally have shorter term investment horizons and view a stock decline as a portent of things to come. These investors are also likely to espouse trading in the direction of the prevailing trend, rather than against it. They may view buying into a stock decline as akin to trying to "catch a falling knife." Such investors and traders are more likely to rely on technical indicators, such as price momentum, to justify their investing actions. Using the example of Widget Co., a short-term trader who initially bought the stock at $50 may have a stop-loss on this trade at $45. If the stock trades below $45, the trader will sell the position in Widget Co. and crystallize the loss. Short-term traders generally do not believe in averaging their positions down, as they see this as throwing good money after bad.
Advantages of Averaging Down
The main advantage of averaging down is that an investor can bring down the average cost of a stock holding quite substantially. Assuming the stock turns around, this ensures a lower breakeven point for the stock position, and higher gains in dollar terms than would have been the case if the position was not averaged down.
In the previous example of Widget Co., by averaging down through the purchase of an additional 100 shares at $40, the investor brings down the breakeven point (or average price) of the position to $45. If Widget Co. stock trades at $49 in another six months, the investor now has a potential gain of $800 (despite the fact that the stock is still trading below the initial entry price of $50).
If Widget Co. continues to rise and advances to $55, the potential gains would be $2,000. By averaging down, the investor has effectively "doubled up" the Widget Co. position. Had the investor not averaged down when the stock declined to $40, the potential gain on the position (when the stock is at $55) would amount to only $500.
Disadvantages
Averaging down or doubling up works well when the stock eventually rebounds because it has the effect of magnifying gains, but if the stock continues to decline, losses are also magnified. In such cases, the investor may rue the decision to average down rather than either exiting the position or not adding to the initial holding.
Investors must therefore take the utmost care to correctly assess the risk profile of the stock being averaged down. While this is no easy feat at the best of times, it becomes an even more difficult task during frenzied bear markets such as that of 2008, when household names such as Fannie Mae, Freddie Mac, AIG and Lehman Brothers lost most of their market capitalization in a matter of months.
Another drawback of averaging down is that it may result in a higher-than-desired weighting of a stock or sector in an investment portfolio. As an example, consider the case of an investor who had a 25% weighting of U.S. bank stocks in a portfolio at the beginning of 2008. If the investor averaged down his or her bank holdings after the precipitous decline in most bank stocks that year so that these stocks made up 35% of the investor's total portfolio. This proportion may represent a higher degree of exposure to bank stocks than that desired, putting the investor at much higher risk.
Practical Applications
Some of the world's most astute investors, including Warren Buffett, have successfully used the averaging down strategy over the years. While the pockets of the average investor are nowhere near as deep as deep as Buffett's, averaging down can still be a viable strategy, albeit with a few caveats:
Averaging down should be done on a selective basis for specific stocks, rather than as a catch-all strategy for every stock in a portfolio. This strategy is best restricted to high-quality, blue-chip stocks where the risk of corporate bankruptcy is low. Blue chips that satisfy stringent criteria - which include a long-term track record, strong competitive position, very low or no debt, stable business, solid cash flows, and sound management - may be suitable candidates for averaging down.
Before averaging down a position, the company's fundamentals should be thoroughly assessed. The investor should ascertain whether a significant decline in a stock is only a temporary phenomenon, or a symptom of a deeper malaise. At a minimum, factors that need to be assessed are the company's competitive position, long-term earnings outlook, business stability and capital structure.
The strategy may be particularly suited to times when there is an inordinate amount of fear and panic in the markets, because panic liquidation may result in high-quality stocks being available at compelling valuations. For example, some of the biggest technology stocks were trading at bargain-basement levels in the summer of 2002, while U.S. and international bank stocks were on sale in the second half of 2008. The key, of course, is exercising prudent judgment in picking the stocks that are best positioned to survive the shakeout.
Conclusion
Averaging down is a viable investment strategy for stocks, mutual funds and exchange-traded funds. However, due care must be exercised in deciding which positions to average down. The strategy is best restricted to blue chips that satisfy stringent selection criteria such as a long-term track record, minimal debt and solid cash flows.
http://biz.yahoo.com/investopedia/081219/4101.html
Lessons from a Very Bad Year
Lessons from a Very Bad Year
by Ben Stein
Posted on Monday, December 22, 2008, 12:00AM
At last, this horrible year is almost behind us. Let's hope we never see another one like it.
If someone had told me that the market -- adjusted for inflation -- would be down by more than it was in the Great Depression while most Americans still basically had high prosperity, I wouldn't have believed it possible. It goes to show what stupendously bad Treasury stewardship can do.
If someone had told me Treasury and the Fed would allow the fourth- or fifth-biggest investment bank in America to fail, I would've scoffed. But they did it, and we got a stock market crash, a severe recession, and national fear as the result. The night Paulson and Bernanke let Lehman fail was the night they drove old American investors down.
Theoretical Failings
Meanwhile, we look to the future. And we try to learn from the past. What have we learned?
1. Efficient market theory is extremely limited as a market predictor in times like these. Efficient market theory says that at any given moment, the market price of all stocks reflects all that is known about them -- the price at any given moment is the best estimate of future price.
This is true as far as it goes. And, again, in most times, it goes very far. But in times when what is not known lurks below the waterline like the bottom of an iceberg, dwarfing what lies above and can be seen, efficient market theory is not only limited in effectiveness but downright dangerous.
It turned out that what lay waiting unknown to most of us -- and to the market -- was a wild miscalculation about the true liabilities associated with credit in this country. The true liability on subprime included staggering amounts of derivatives, a high multiple of subprime itself. Ditto for credit card debt, and now, as we're seeing, ditto for commercial mortgage debt.
Not only was that debt questionable, but players had added super-sized bets so big that the markets simply couldn't adjust to them without a serious correction.
Mr. Market Gets It Wrong
So efficient market theory is sunk. The problem is that we have nothing else to replace it except the predictions of many different analysts. Some are right and some are wrong, and they're usually not even close to being as helpful as Mr. Market.
But as my pal Jim Grant notes in his masterful new book, "Mr. Market Miscalculates: The Bubble Years and Beyond," the market is far from infallible and can lead the investor to disaster. Efficient market theory is highly fallible, but it may still be better than anything else.
Bye-Bye, Buy and Hold?
Another lesson to be drawn from this year:
2. Buy and hold as a strategy is very questionable, as my pal Robert Lobban says. It's worked in the past, but in times of severe market stress it just doesn't work. We've now gone 10 years -- many of which were banner years for profits -- without a gain in the broad indices. In some areas, such as REITs and commodities and energy and autos, the losses have been breathtaking.
But trading doesn't work well for most investors either. Even for the best hedge fund geniuses (and actually I don't consider them geniuses at all), trading has often been a catastrophe in the last 15 months.
So, what's the solution? Ben Graham, a real genius who mentored Warren Buffett, concluded near the end of his life that stocks were simply too risky and investors should only be in Treasury bonds.
My pal, Phil DeMuth, along with many others, has long said that investors should have half in bonds. He's right, but even bonds, except for Treasuries, have been whacked this year. But his approach is definitely the right one. Ray Lucia, a super-smart investment guru, says you should have seven years of expenses in cash or near-cash to ride out events like this if you're retired or close to retirement. This turns out to be a simply brilliant suggestion. Ray has a lot of them.
What we're left with is maybe that buy and hold is far from perfect, but if we have enough cash to get us through the bad times we might yet see it work. If not, one hardly knows what to suggest.
Historical Ignorance
The final lesson from 2008:
3. We can't count on the people who rule us to have learned a darned thing from past history. "Those who do not know the past are condemned to repeat it," said the famous Harvard philosopher George Santayana.
Of course, that's a cliche by now and has been for decades. But it is true of Henry Paulson, our pitiful Secretary of the Treasury and, very, very sadly, of Ben Bernanke, our Fed chairman.
Paulson is simply an ignorant, bullying fraud. I never expected much from him. But Bernanke is a scholar, or so I thought, and should've known better than to destroy confidence by allowing Lehman to fail. That was a mistake that no real student of the Great Depression, as Bernanke is, should've made. I would never have thought it could happen, but it did.
It makes me wonder what other mistakes and foolishness our rulers have in mind, and it scares me plenty.
Only Human
In the meantime, please don't blame yourself for your losses. We all make mistakes, yours truly especially. My hat is off to those like Doug Kass who saw it all coming. My hat is not off to those who claimed afterward to have seen it coming. I have met so many people who tell me they sold out in October 2007 that I think I must be the only person left in this country with any stock. (That would make me by far the richest man on the planet, and I guarantee that I'm not.)
We're just human beings with human failings. Efficient market theory fooled us. Buy and hold fooled us. Trust in government fooled us. My own failings fooled me. Something else will fool us next time. As my grandmother used to say when her children made a mistake, "Don't worry, you'll do it again." If we learn even a little from what's happened, we're far ahead of Henry Paulson.
In that spirit, have a Merry Christmas, Happy Hanukkah, and Happy New Year.
http://finance.yahoo.com/expert/article/yourlife/130751;_ylt=AgK_TOlH.RnkvqbqB2UHhnO7YWsA
by Ben Stein
Posted on Monday, December 22, 2008, 12:00AM
At last, this horrible year is almost behind us. Let's hope we never see another one like it.
If someone had told me that the market -- adjusted for inflation -- would be down by more than it was in the Great Depression while most Americans still basically had high prosperity, I wouldn't have believed it possible. It goes to show what stupendously bad Treasury stewardship can do.
If someone had told me Treasury and the Fed would allow the fourth- or fifth-biggest investment bank in America to fail, I would've scoffed. But they did it, and we got a stock market crash, a severe recession, and national fear as the result. The night Paulson and Bernanke let Lehman fail was the night they drove old American investors down.
Theoretical Failings
Meanwhile, we look to the future. And we try to learn from the past. What have we learned?
1. Efficient market theory is extremely limited as a market predictor in times like these. Efficient market theory says that at any given moment, the market price of all stocks reflects all that is known about them -- the price at any given moment is the best estimate of future price.
This is true as far as it goes. And, again, in most times, it goes very far. But in times when what is not known lurks below the waterline like the bottom of an iceberg, dwarfing what lies above and can be seen, efficient market theory is not only limited in effectiveness but downright dangerous.
It turned out that what lay waiting unknown to most of us -- and to the market -- was a wild miscalculation about the true liabilities associated with credit in this country. The true liability on subprime included staggering amounts of derivatives, a high multiple of subprime itself. Ditto for credit card debt, and now, as we're seeing, ditto for commercial mortgage debt.
Not only was that debt questionable, but players had added super-sized bets so big that the markets simply couldn't adjust to them without a serious correction.
Mr. Market Gets It Wrong
So efficient market theory is sunk. The problem is that we have nothing else to replace it except the predictions of many different analysts. Some are right and some are wrong, and they're usually not even close to being as helpful as Mr. Market.
But as my pal Jim Grant notes in his masterful new book, "Mr. Market Miscalculates: The Bubble Years and Beyond," the market is far from infallible and can lead the investor to disaster. Efficient market theory is highly fallible, but it may still be better than anything else.
Bye-Bye, Buy and Hold?
Another lesson to be drawn from this year:
2. Buy and hold as a strategy is very questionable, as my pal Robert Lobban says. It's worked in the past, but in times of severe market stress it just doesn't work. We've now gone 10 years -- many of which were banner years for profits -- without a gain in the broad indices. In some areas, such as REITs and commodities and energy and autos, the losses have been breathtaking.
But trading doesn't work well for most investors either. Even for the best hedge fund geniuses (and actually I don't consider them geniuses at all), trading has often been a catastrophe in the last 15 months.
So, what's the solution? Ben Graham, a real genius who mentored Warren Buffett, concluded near the end of his life that stocks were simply too risky and investors should only be in Treasury bonds.
My pal, Phil DeMuth, along with many others, has long said that investors should have half in bonds. He's right, but even bonds, except for Treasuries, have been whacked this year. But his approach is definitely the right one. Ray Lucia, a super-smart investment guru, says you should have seven years of expenses in cash or near-cash to ride out events like this if you're retired or close to retirement. This turns out to be a simply brilliant suggestion. Ray has a lot of them.
What we're left with is maybe that buy and hold is far from perfect, but if we have enough cash to get us through the bad times we might yet see it work. If not, one hardly knows what to suggest.
Historical Ignorance
The final lesson from 2008:
3. We can't count on the people who rule us to have learned a darned thing from past history. "Those who do not know the past are condemned to repeat it," said the famous Harvard philosopher George Santayana.
Of course, that's a cliche by now and has been for decades. But it is true of Henry Paulson, our pitiful Secretary of the Treasury and, very, very sadly, of Ben Bernanke, our Fed chairman.
Paulson is simply an ignorant, bullying fraud. I never expected much from him. But Bernanke is a scholar, or so I thought, and should've known better than to destroy confidence by allowing Lehman to fail. That was a mistake that no real student of the Great Depression, as Bernanke is, should've made. I would never have thought it could happen, but it did.
It makes me wonder what other mistakes and foolishness our rulers have in mind, and it scares me plenty.
Only Human
In the meantime, please don't blame yourself for your losses. We all make mistakes, yours truly especially. My hat is off to those like Doug Kass who saw it all coming. My hat is not off to those who claimed afterward to have seen it coming. I have met so many people who tell me they sold out in October 2007 that I think I must be the only person left in this country with any stock. (That would make me by far the richest man on the planet, and I guarantee that I'm not.)
We're just human beings with human failings. Efficient market theory fooled us. Buy and hold fooled us. Trust in government fooled us. My own failings fooled me. Something else will fool us next time. As my grandmother used to say when her children made a mistake, "Don't worry, you'll do it again." If we learn even a little from what's happened, we're far ahead of Henry Paulson.
In that spirit, have a Merry Christmas, Happy Hanukkah, and Happy New Year.
http://finance.yahoo.com/expert/article/yourlife/130751;_ylt=AgK_TOlH.RnkvqbqB2UHhnO7YWsA
We explain why deflation (falling prices) could wreak havoc with your finances
From The Times
December 18, 2008
The party's over if deflation grips the economy
We explain why falling prices could wreak havoc with your finances
Inflation is tumbling and fears are growing that deflation, where prices actually start falling, may become a feature of the economy next year.
This week the Office for National Statistics reported that the consumer prices index (CPI), a key measure of inflation, fell to 4.1 per cent last month, down from a high of 5.2 per cent in September. Jonathan Loynes, chief European economist at Capital Economics, the consultancy, says: “November's CPI figures are another step along the path that is likely to lead to the first bout of deflation in the UK for almost half a century.”
While falling prices may sound great, deflation is actually considered bad for the economy. When prices fall, consumers defer purchases on the assumption that they will be able to buy the same goods cheaper at a later date. This damages demand which can undermine company profits, trigger unemployment and entrench a destructive economic cycle.
Here we explain what falling prices might also mean for your savings, investments, pension, house price and mortgage - and how to guard against the worst effects.
Related Links
Q&A: deflation
Spending power down in 70% of households
Savings
To some extent, deflation is good news for savers because it increases the size of deposits relative to prices, making them more valuable in real terms. However, the downside is that the rates on savings accounts are likely to tumble if deflation takes hold because the Bank of England would reduce the base rate to 0 per cent or close to it. Savings rates are already falling fast. At the start of October, when the base rate was at 5 per cent, you could lock in to accounts paying an impressive 7 per cent. But now, with the base rate at 2 per cent, the most you can earn is about 5.5 per cent.
Returns in Japan, which suffered a decade of deflation, are close to non-existant. Simon Somerville, of Jupiter Asset Management, says: “The most you can earn from a Japanese bank account is about 0.4 per cent, but most pay nothing in interest. It is no wonder that many Japanese savers have abandoned banks and put their cash in safes or under the mattress.”
Savers in the UK may not end up quite so badly off, but only because our banks desperately need to bolster their finances. Some may continue to offer decent rates, as it is one of the easiest ways for them to raise money. So the pitiful state of the UK's banking system could yet offer a silver lining for savers.
Kevin Mountford, of the comparison website moneysupermarket.com, says that the best way for savers to guard against falling returns is to lock in to a long-term fixed-rate account. He says: “The best one-year fixed rate is from Anglo Irish Bank, at 5 per cent, but be quick as such rates could disappear soon. It is probably safe to lock up savings for up to two years, but any longer and there is a risk that the base rate - and savings rates - will start moving higher again. Nationwide is offering a two-year Isa bond paying 4 per cent.”
Pensions
Deflation could wreak havoc with retirement plans, especially if the problem persists for years. As prices fall, so will corporate profits and stock market investments. Given that many individuals and companies rely on shares to fund pension growth, many savers will have their retirement plans cast into doubt. Tumbling share prices have already wiped nearly a quarter off the average personal pension fund in the past year.
Even investors in final-salary plans, which guarantee a pension based on income, could hit the skids. As companies struggle to finance their pensions, the remaining final-salary schemes could close en masse. Even the Government, which backs the biggest final-salary scheme of all for public sector workers, may be forced to take drastic action, perhaps closing it to new entrants.
Tom McPhail, of Hargreaves Lansdown, the independent financial adviser, says that anyone approaching retirement should consider locking into an annuity sooner rather than later. He says: “As long as your pension fund has not been decimated by the recent stock market turmoil now might be a good time to buy a retirement income because annuity rates could well fall over the coming year or so. If you can afford to do so, deferring your state pension could also help. Provided that you are prepared to take the longevity and political risk - by which I mean that you don't think that you will die any time soon and you trust the Government to meet its promises - then you can boost retirement income by 10.4 per cent for every year you defer taking your pension.”
Those who are already retired could be among the few winners. Benefits, including the state pension, are linked to the retail prices index and can't be cut if inflation goes negative. The worst that can happen is that benefits remain unchanged. Many pensioners have fixed incomes, so inflation erodes their spending power. If prices drop, they will be able to buy more with their pensions.
House prices and mortgages
Homeowners are already experiencing deflation, with the average house price having fallen by almost 15 per cent over the past year, according to the Halifax.
Deflation in the wider economy would be a further blow because mortgage debt would increase in real terms, by becoming more expensive relative to prices. Fionnuala Earley, Nationwide's chief economist, explains: “Inflation tends to be good for borrowers, as it shrinks the real size of debt. In inflationary periods, wages also tend to rise, making it easier to meet mortgage payments. If there were deflation, debt would hang around longer and even grow in real terms, as wages would not be increasing and prices in the shops would be falling.”
Sadly, there is little that borrowers can do to mitigate the effects of deflation. Melanie Bien, of Savills Private Finance, the mortgage broker, says: “The first step is to keep up with your repayments. The mortgage should be your priority; everything else should be paid after that. You can also help by reducing your mortgage by overpaying. If you are lucky enough to have a tracker mortgage, you could overpay by the amount you are saving from lower interest rates.”
Most lenders will let you overpay by up to 10 per cent of your mortgage each year without penalty.
Ms Bien adds: “If you have an interest-only deal, it is worth considering switching to a repayment mortgage to ensure that the capital is paid off by the end of the mortgage term. This will mean significantly higher monthly payments, but it will be worth it in the long run. Speak to your lender about switching - it is very straightforward and can usually be arranged over the phone.”
Recent housing market history gives no indication whether residential property would be viewed as an attractive investment during a sustained period of deflation. Mortgages would continue to be available but the miserable experience of overextended borrowers could result in widespread aversion to debt, particularly among members of the younger generation.
At the same time, the lack of any meaningful returns from savings might persuade some people with spare cash to put it into property because bricks and mortar would be a tangible asset in an unfamiliar and insecure environment.
Additional reporting by David Budworth
Japan still licking its wounds
The most recent guide to what deflation might mean for UK investors is to look at what happened in Japan in the 1990s, writes Mark Atherton.
When Japan's property and stock market bubble burst with a vengeance in the early 1990s, the country experienced a prolonged period of deflation.
With consumers reluctant to spend because of falling prices, the economy stagnated, company profits fell and the stock market tumbled. The Nikkei index stood at nearly 39,000 at the start of the 1990s but now stands at a lowly 8,500, even though deflation has been eradicated for the time being.
John Hatherly, of Seven Investment Management, says: “What happened was that everyone started to draw in their horns and conserve their cash, rather than put it into assets that were falling in value. Investors deserted shares and property for safer havens.”
One of these safe havens was government bonds. Mick Gilligan, of Killik & Co, the stockbroker, says: “Investors reckoned, correctly, that the Japanese Government would not go bust and that government bonds were a safe bet, even though the interest they paid was small.”
Corporate bonds, on the other hand, tend not to fare so well in deflationary times because, with profits falling, there is less money to cover the bond interest payments and there is always the possibility of defaults on the payments or a collapse in the value of the bond itself if the company goes bust.
http://www.timesonline.co.uk/tol/money/consumer_affairs/article5366383.ece
December 18, 2008
The party's over if deflation grips the economy
We explain why falling prices could wreak havoc with your finances
Inflation is tumbling and fears are growing that deflation, where prices actually start falling, may become a feature of the economy next year.
This week the Office for National Statistics reported that the consumer prices index (CPI), a key measure of inflation, fell to 4.1 per cent last month, down from a high of 5.2 per cent in September. Jonathan Loynes, chief European economist at Capital Economics, the consultancy, says: “November's CPI figures are another step along the path that is likely to lead to the first bout of deflation in the UK for almost half a century.”
While falling prices may sound great, deflation is actually considered bad for the economy. When prices fall, consumers defer purchases on the assumption that they will be able to buy the same goods cheaper at a later date. This damages demand which can undermine company profits, trigger unemployment and entrench a destructive economic cycle.
Here we explain what falling prices might also mean for your savings, investments, pension, house price and mortgage - and how to guard against the worst effects.
Related Links
Q&A: deflation
Spending power down in 70% of households
Savings
To some extent, deflation is good news for savers because it increases the size of deposits relative to prices, making them more valuable in real terms. However, the downside is that the rates on savings accounts are likely to tumble if deflation takes hold because the Bank of England would reduce the base rate to 0 per cent or close to it. Savings rates are already falling fast. At the start of October, when the base rate was at 5 per cent, you could lock in to accounts paying an impressive 7 per cent. But now, with the base rate at 2 per cent, the most you can earn is about 5.5 per cent.
Returns in Japan, which suffered a decade of deflation, are close to non-existant. Simon Somerville, of Jupiter Asset Management, says: “The most you can earn from a Japanese bank account is about 0.4 per cent, but most pay nothing in interest. It is no wonder that many Japanese savers have abandoned banks and put their cash in safes or under the mattress.”
Savers in the UK may not end up quite so badly off, but only because our banks desperately need to bolster their finances. Some may continue to offer decent rates, as it is one of the easiest ways for them to raise money. So the pitiful state of the UK's banking system could yet offer a silver lining for savers.
Kevin Mountford, of the comparison website moneysupermarket.com, says that the best way for savers to guard against falling returns is to lock in to a long-term fixed-rate account. He says: “The best one-year fixed rate is from Anglo Irish Bank, at 5 per cent, but be quick as such rates could disappear soon. It is probably safe to lock up savings for up to two years, but any longer and there is a risk that the base rate - and savings rates - will start moving higher again. Nationwide is offering a two-year Isa bond paying 4 per cent.”
Pensions
Deflation could wreak havoc with retirement plans, especially if the problem persists for years. As prices fall, so will corporate profits and stock market investments. Given that many individuals and companies rely on shares to fund pension growth, many savers will have their retirement plans cast into doubt. Tumbling share prices have already wiped nearly a quarter off the average personal pension fund in the past year.
Even investors in final-salary plans, which guarantee a pension based on income, could hit the skids. As companies struggle to finance their pensions, the remaining final-salary schemes could close en masse. Even the Government, which backs the biggest final-salary scheme of all for public sector workers, may be forced to take drastic action, perhaps closing it to new entrants.
Tom McPhail, of Hargreaves Lansdown, the independent financial adviser, says that anyone approaching retirement should consider locking into an annuity sooner rather than later. He says: “As long as your pension fund has not been decimated by the recent stock market turmoil now might be a good time to buy a retirement income because annuity rates could well fall over the coming year or so. If you can afford to do so, deferring your state pension could also help. Provided that you are prepared to take the longevity and political risk - by which I mean that you don't think that you will die any time soon and you trust the Government to meet its promises - then you can boost retirement income by 10.4 per cent for every year you defer taking your pension.”
Those who are already retired could be among the few winners. Benefits, including the state pension, are linked to the retail prices index and can't be cut if inflation goes negative. The worst that can happen is that benefits remain unchanged. Many pensioners have fixed incomes, so inflation erodes their spending power. If prices drop, they will be able to buy more with their pensions.
House prices and mortgages
Homeowners are already experiencing deflation, with the average house price having fallen by almost 15 per cent over the past year, according to the Halifax.
Deflation in the wider economy would be a further blow because mortgage debt would increase in real terms, by becoming more expensive relative to prices. Fionnuala Earley, Nationwide's chief economist, explains: “Inflation tends to be good for borrowers, as it shrinks the real size of debt. In inflationary periods, wages also tend to rise, making it easier to meet mortgage payments. If there were deflation, debt would hang around longer and even grow in real terms, as wages would not be increasing and prices in the shops would be falling.”
Sadly, there is little that borrowers can do to mitigate the effects of deflation. Melanie Bien, of Savills Private Finance, the mortgage broker, says: “The first step is to keep up with your repayments. The mortgage should be your priority; everything else should be paid after that. You can also help by reducing your mortgage by overpaying. If you are lucky enough to have a tracker mortgage, you could overpay by the amount you are saving from lower interest rates.”
Most lenders will let you overpay by up to 10 per cent of your mortgage each year without penalty.
Ms Bien adds: “If you have an interest-only deal, it is worth considering switching to a repayment mortgage to ensure that the capital is paid off by the end of the mortgage term. This will mean significantly higher monthly payments, but it will be worth it in the long run. Speak to your lender about switching - it is very straightforward and can usually be arranged over the phone.”
Recent housing market history gives no indication whether residential property would be viewed as an attractive investment during a sustained period of deflation. Mortgages would continue to be available but the miserable experience of overextended borrowers could result in widespread aversion to debt, particularly among members of the younger generation.
At the same time, the lack of any meaningful returns from savings might persuade some people with spare cash to put it into property because bricks and mortar would be a tangible asset in an unfamiliar and insecure environment.
Additional reporting by David Budworth
Japan still licking its wounds
The most recent guide to what deflation might mean for UK investors is to look at what happened in Japan in the 1990s, writes Mark Atherton.
When Japan's property and stock market bubble burst with a vengeance in the early 1990s, the country experienced a prolonged period of deflation.
With consumers reluctant to spend because of falling prices, the economy stagnated, company profits fell and the stock market tumbled. The Nikkei index stood at nearly 39,000 at the start of the 1990s but now stands at a lowly 8,500, even though deflation has been eradicated for the time being.
John Hatherly, of Seven Investment Management, says: “What happened was that everyone started to draw in their horns and conserve their cash, rather than put it into assets that were falling in value. Investors deserted shares and property for safer havens.”
One of these safe havens was government bonds. Mick Gilligan, of Killik & Co, the stockbroker, says: “Investors reckoned, correctly, that the Japanese Government would not go bust and that government bonds were a safe bet, even though the interest they paid was small.”
Corporate bonds, on the other hand, tend not to fare so well in deflationary times because, with profits falling, there is less money to cover the bond interest payments and there is always the possibility of defaults on the payments or a collapse in the value of the bond itself if the company goes bust.
http://www.timesonline.co.uk/tol/money/consumer_affairs/article5366383.ece
Monday 22 December 2008
'Savers are going to have to step up to the risk plate at some stage'
'Savers are going to have to step up to the risk plate at some stage'
The real prospect that rates will fall to zero is a nightmare scenario for those that rely on savings income to bolster their day-to-day living expenses.
By Paul FarrowLast Updated: 7:31AM GMT 11 Dec 2008
Comments 2 Comment on this article
It is hard to imagine savings rates at nil - but it happened in Japan, where savers had no choice but to deal with the harsh reality of not getting a return on their money.
Take a look at this excerpt from the newswires in July 2006 when the Bank of Japan decided to raise rates for the first time in six years from zero to 0.25pc.
"Mizuho Financial, Japan's second largest bank, said last week it would raise interest rates on six-month time deposits for the first occasion in almost six years. It raised the rate for six months to 0.1pc from 0.02pc and the rate for three month accounts to 0.06pc from 0.02pc from July 10. Smaller Sumitomo Mitsui Financial also raised rates on time deposits on Monday.''
Apathetic savers are already getting a pittance on their cash - many of Halifax's savings accounts pay 0.5pc or less already.
For the proactive saver, as Emma Simon reports on page 1, there are ways to get a return on your money over and above 2pc. But you will have to get your skates on to grab a decent deal.
As one commentator remarked last week, savers are going to have to take on a little more risk if they are to get their just rewards. With rates around 6pc, the decision to hoard cash in savings accounts made perfect sense, but the landscape is changing.
As I mentioned a fortnight ago, corporate bond funds offer a decent yield as do many equity income funds. They are by no means a substitute for cash but, if rates languish at such low levels for too long, savers are going to have little choice but to step up to the risk plate at some stage.
It is a different ball game for borrowers, however. When interest rates reached 15pc in 1990, I was green with envy of my bosses at Coutts. The longest standing managers at the Queen's bank were fortunate to have fixed rate mortgages of just 2pc. A perk if ever there was one.
It seemed inconceivable at the time that I or anyone else could pay a miserly 2pc on a home loan - until this week, that is. True, many borrowers won't be paying anything like 2pc. For starters, around half of mortgages are fixed-rate, while more 10pc of home owners are on their lender's standard variable rates and they range between 4pc and 7pc.
However, some lucky borrowers will be paying less than 1pc. C&G, for instance, was offering a two-year tracker discounting base rate by 1.01pc. One can only assume that these borrowers now paying 0.99pc will pay zilch interest if rates tumble to zero. Many lenders were predictably slow to react, or did react but failed to pass on the full one percentage point cut.
But it made a welcome change to see a lender put its customers first for once. Nationwide decided not enforce its collar on tracker mortgages. A collar allows lenders not to pass on interest rate reductions once base rate falls below a certain level - in Nationwide's case, it was 2.75pc. Mind you, I'm fortunate enough to have a two-year tracker from the building society at 0.03pc above base rate. I'll leave it to you to do the maths.
http://www.telegraph.co.uk/finance/personalfinance/comment/paulfarrow/3690421/Savers-are-going-to-have-to-step-up-to-the-risk-plate-at-some-stage.html
The real prospect that rates will fall to zero is a nightmare scenario for those that rely on savings income to bolster their day-to-day living expenses.
By Paul FarrowLast Updated: 7:31AM GMT 11 Dec 2008
Comments 2 Comment on this article
It is hard to imagine savings rates at nil - but it happened in Japan, where savers had no choice but to deal with the harsh reality of not getting a return on their money.
Take a look at this excerpt from the newswires in July 2006 when the Bank of Japan decided to raise rates for the first time in six years from zero to 0.25pc.
"Mizuho Financial, Japan's second largest bank, said last week it would raise interest rates on six-month time deposits for the first occasion in almost six years. It raised the rate for six months to 0.1pc from 0.02pc and the rate for three month accounts to 0.06pc from 0.02pc from July 10. Smaller Sumitomo Mitsui Financial also raised rates on time deposits on Monday.''
Apathetic savers are already getting a pittance on their cash - many of Halifax's savings accounts pay 0.5pc or less already.
For the proactive saver, as Emma Simon reports on page 1, there are ways to get a return on your money over and above 2pc. But you will have to get your skates on to grab a decent deal.
As one commentator remarked last week, savers are going to have to take on a little more risk if they are to get their just rewards. With rates around 6pc, the decision to hoard cash in savings accounts made perfect sense, but the landscape is changing.
As I mentioned a fortnight ago, corporate bond funds offer a decent yield as do many equity income funds. They are by no means a substitute for cash but, if rates languish at such low levels for too long, savers are going to have little choice but to step up to the risk plate at some stage.
It is a different ball game for borrowers, however. When interest rates reached 15pc in 1990, I was green with envy of my bosses at Coutts. The longest standing managers at the Queen's bank were fortunate to have fixed rate mortgages of just 2pc. A perk if ever there was one.
It seemed inconceivable at the time that I or anyone else could pay a miserly 2pc on a home loan - until this week, that is. True, many borrowers won't be paying anything like 2pc. For starters, around half of mortgages are fixed-rate, while more 10pc of home owners are on their lender's standard variable rates and they range between 4pc and 7pc.
However, some lucky borrowers will be paying less than 1pc. C&G, for instance, was offering a two-year tracker discounting base rate by 1.01pc. One can only assume that these borrowers now paying 0.99pc will pay zilch interest if rates tumble to zero. Many lenders were predictably slow to react, or did react but failed to pass on the full one percentage point cut.
But it made a welcome change to see a lender put its customers first for once. Nationwide decided not enforce its collar on tracker mortgages. A collar allows lenders not to pass on interest rate reductions once base rate falls below a certain level - in Nationwide's case, it was 2.75pc. Mind you, I'm fortunate enough to have a two-year tracker from the building society at 0.03pc above base rate. I'll leave it to you to do the maths.
http://www.telegraph.co.uk/finance/personalfinance/comment/paulfarrow/3690421/Savers-are-going-to-have-to-step-up-to-the-risk-plate-at-some-stage.html
House prices to crash 30 per cent, Barclays chief executive John Varley warns
House prices to crash 30 per cent, Barclays chief executive John Varley warns
House prices will crash a further 15 per cent next year, the boss of high street bank Barclays has admitted.
By Myra Butterworth, Personal Finance Correspondent Last Updated: 8:52AM GMT 15 Dec 2008
John Varley of Barclays Photo: Daniel Jones
In a remarkably candid interview, John Varley, the group chief executive of Barclays, warned that Britain is only mid way through the house price slump - meaning the total fall could be as much as 30 per cent.
He described as "madness" the previous lending policies' of banks, in which 100 per cent mortgages and beyond were approved.
Mr Varley admitted that banks were partly to blame for the current recession, saying it was time they showed "humility" and said "sorry" to customers for their role in the sharp economic downturn.
He said banks needed "to take their share of responsibility".
It is the first time that the chief executive of a major bank has spoken so openly in the current climate about the role lenders have played in the sharp turnaround in home owners' fortunes.
The admission comes on the back of the Government giving banks billions of pounds of financial support following the worst banking crisis since 1929. Barclays did not receive government funding.
Mr Varley's comments, made to Jeff Randall, the Daily Telegraph's editor-at-large and to be shown on Sky News this evening, are a dire warning to families across Britain who have already seen the value of their savings and homes plummet amid the credit crisis. They could dissuade potential buyers from seeking loans or moving home. Jonathan Cornell, of mortgage brokers Hamptons Mortgages, said Mr Varley's comments could aggravate the situation further.
The average home in Britain has already dropped £36,000 in value since August last year, according to the country's biggest lenders Halifax. Its latest figures show the average value is now just £163,605.
A further 15 per cent fall would see the average value of a home crash by an additional £25,000 to less than £140,000 based on these figures.
Mr Varley said: "Our view was that from the top to the bottom, you would see a fall of something like 25 to 30 per cent. I suspect we're about halfway through that at the moment. I mean that slowdown, the negative house price inflation started in 2007, it's accelerated in 2008.
"We're probably about halfway through that period, so in other words we've got another 10 to 15 per cent to fall between now and the end of next year. That would be our assessment."
The house price crash has already left many homeowners in negative equity, where the value of their home is worth less than their mortgage.
In the early 1990s, when house prices fell by 10.6 per cent over a prolonged period, 1.8 million home owners had to stay put or face losing thousands when they sold up.
The borrowers who are most vulnerable are those who bought a home with a loan of at least 100 per cent of the value of their property.
At the height of the property boom, when banks were more willing to lend, loans were available at 125 per cent of the value of a property.
Asked for his reaction to the practice, Mr Varley said: "Looking back on it, madness."
Mortgage experts said that lenders would need to offer a wider range of deals to borrowers before the property market showed any signs of recovery.
Melanie Bien, of mortgage brokers Savills Private Finance, said: "Those hoping that the bottom of the housing market had already been reached will have to wait a bit longer with around another 10 per cent drop in prices in 2009 forecast.
"It will then be a while before prices recover but once the bottom has been reached, potential buyers will once again show an interest in purchasing. All we need then is more choice of product at 90 per cent loan-to-value with better rates than are currently available to help first-time buyers in particular onto the housing ladder."
Home sellers have been forced to lower their asking prices dramatically in the past month to achieve a sale.
Around £5,000 was knocked off the average price of a home in the past month, according to property website Rightmove.
It said the average value of a home in Britain dropped from £222,979 in November to £217,808 this month, a fall of 2.3 per cent. House prices are now 10.2 per cent down from May this year.
The figures are higher than those produced by Halifax as they are based on asking prices rather than completions.
Rightmove forecasts that house prices will fall an extra 10 per cent by the end of next year. However, its survey also suggested that the sale prices actually being achieved by estate agents is already down 25 per cent since May.
http://www.telegraph.co.uk/finance/economics/houseprices/3759542/House-prices-to-crash-30-per-cent-Barclays-chief-executive-John-Varley-warns.html
House prices will crash a further 15 per cent next year, the boss of high street bank Barclays has admitted.
By Myra Butterworth, Personal Finance Correspondent Last Updated: 8:52AM GMT 15 Dec 2008
John Varley of Barclays Photo: Daniel Jones
In a remarkably candid interview, John Varley, the group chief executive of Barclays, warned that Britain is only mid way through the house price slump - meaning the total fall could be as much as 30 per cent.
He described as "madness" the previous lending policies' of banks, in which 100 per cent mortgages and beyond were approved.
Mr Varley admitted that banks were partly to blame for the current recession, saying it was time they showed "humility" and said "sorry" to customers for their role in the sharp economic downturn.
He said banks needed "to take their share of responsibility".
It is the first time that the chief executive of a major bank has spoken so openly in the current climate about the role lenders have played in the sharp turnaround in home owners' fortunes.
The admission comes on the back of the Government giving banks billions of pounds of financial support following the worst banking crisis since 1929. Barclays did not receive government funding.
Mr Varley's comments, made to Jeff Randall, the Daily Telegraph's editor-at-large and to be shown on Sky News this evening, are a dire warning to families across Britain who have already seen the value of their savings and homes plummet amid the credit crisis. They could dissuade potential buyers from seeking loans or moving home. Jonathan Cornell, of mortgage brokers Hamptons Mortgages, said Mr Varley's comments could aggravate the situation further.
The average home in Britain has already dropped £36,000 in value since August last year, according to the country's biggest lenders Halifax. Its latest figures show the average value is now just £163,605.
A further 15 per cent fall would see the average value of a home crash by an additional £25,000 to less than £140,000 based on these figures.
Mr Varley said: "Our view was that from the top to the bottom, you would see a fall of something like 25 to 30 per cent. I suspect we're about halfway through that at the moment. I mean that slowdown, the negative house price inflation started in 2007, it's accelerated in 2008.
"We're probably about halfway through that period, so in other words we've got another 10 to 15 per cent to fall between now and the end of next year. That would be our assessment."
The house price crash has already left many homeowners in negative equity, where the value of their home is worth less than their mortgage.
In the early 1990s, when house prices fell by 10.6 per cent over a prolonged period, 1.8 million home owners had to stay put or face losing thousands when they sold up.
The borrowers who are most vulnerable are those who bought a home with a loan of at least 100 per cent of the value of their property.
At the height of the property boom, when banks were more willing to lend, loans were available at 125 per cent of the value of a property.
Asked for his reaction to the practice, Mr Varley said: "Looking back on it, madness."
Mortgage experts said that lenders would need to offer a wider range of deals to borrowers before the property market showed any signs of recovery.
Melanie Bien, of mortgage brokers Savills Private Finance, said: "Those hoping that the bottom of the housing market had already been reached will have to wait a bit longer with around another 10 per cent drop in prices in 2009 forecast.
"It will then be a while before prices recover but once the bottom has been reached, potential buyers will once again show an interest in purchasing. All we need then is more choice of product at 90 per cent loan-to-value with better rates than are currently available to help first-time buyers in particular onto the housing ladder."
Home sellers have been forced to lower their asking prices dramatically in the past month to achieve a sale.
Around £5,000 was knocked off the average price of a home in the past month, according to property website Rightmove.
It said the average value of a home in Britain dropped from £222,979 in November to £217,808 this month, a fall of 2.3 per cent. House prices are now 10.2 per cent down from May this year.
The figures are higher than those produced by Halifax as they are based on asking prices rather than completions.
Rightmove forecasts that house prices will fall an extra 10 per cent by the end of next year. However, its survey also suggested that the sale prices actually being achieved by estate agents is already down 25 per cent since May.
http://www.telegraph.co.uk/finance/economics/houseprices/3759542/House-prices-to-crash-30-per-cent-Barclays-chief-executive-John-Varley-warns.html
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