Don't Make These Three Investment Mistakes

Don't Make These Three Investment Mistakes
Christopher Davis
Tuesday December 9, 2008, 7:00 am EST


In the world of traditional economists and finance professors, though, that's not supposed to happen. If investors are rational decision-makers, then emotion-driven bubbles shouldn't be possible. Yet human weaknesses can limit our ability to think clearly. Many studies of investor behavior have shown that investors are:

• too willing to extrapolate recent trends far into the future,


• too confident in their abilities, and


• too quick (or not quick enough) to react to new information.

These tendencies often lead investors to make decisions that run counter to their own best interests.


The idea that investor psychology can result in poor investment decisions is a key insight of an increasingly influential field of study called behavioral finance. Behavioral-finance theorists blend finance and psychology to identify deep-seated human traits that get in the way of investment success. Behavioral finance isn't just an interesting academic diversion, however. Its findings can help you identify--and correct--behaviors that cost you money.


What commonplace mistakes should investors avoid? Here are a few key behavioral-finance lessons worth heeding.


Don't Read Too Much into the Recent Past



When faced with lots of information, most people come up with easy rules of thumb to help them cope. While useful in some situations, these shortcuts can lead to biases that cause investors to make bad decisions. One example is "extrapolation bias," the overreliance on the past to assess the future. Instead of doing all the necessary and possibly tedious homework in researching a potential investment, investors instead "anchor" their expectations for the future in the recent past.


The problem, of course, is that yesterday doesn't always tell you what tomorrow will bring. If you don't believe us, just ask investors who swarmed red-hot technology- and Internet-focused stocks in 1999 and 2000 expecting the good times to continue. They didn't, and most folks ended up suffering huge losses. Those who dove into real estate or natural-resources funds in more recent years are learning the same lesson now.


It's also worth pointing out that you can make the same mistake in the other direction. It's been a horrible year for the markets, but that won't last forever either. Just as it's a mistake to assume the good times will never end, it's also foolish to think in bad times that they'll never end.


Realize That You Don't Know As Much As You Think



In a 1981 study asking Swedish drivers to assess their own driving abilities, 90% rated themselves as above average. Statistically speaking, that's just not possible. But most of us are just like the Swedes: We think that we're more capable and smarter than we really are. As an investor, you should check your excessive optimism at the door. You might believe you're more likely than the next guy to spot the next Microsoft (NasdaqGS:MSFT - News), but the odds are you're not.


According to several studies, overconfident investors trade more rapidly because they think that they know more than the person on the other side of the trade. And all that trading can be hazardous to your wealth, as University of California, Berkeley professors Brad Barber and Terrance Odean put it in their 2000 study of investor trading behavior. The study looked at approximately 66,000 households using a discount broker between 1991 and 1996 and found that individuals who trade frequently (with monthly turnover above 8.8%) earned a net annualized return of 11.4% over that time, while inactive accounts netted 18.5%. Investors who traded most often paid the most in brokerage commissions, taking a huge bite out of returns.


All that trading might've been worthwhile if investors replaced the stocks they sold with something better. But interestingly, the study found that, excluding trading costs, newly acquired stocks actually slightly underperformed the stocks that were sold. That means that rapid traders' returns suffered whether or not fees were taken into account. Some researchers have come to a similar conclusion studying fund manager trading--standing pat is often the best strategy.


Keep Your Winners Longer and Dump Your Losers Sooner



Investors in Odean and Barber's study were much more likely to sell winners than losers. That's exactly what behavioral-finance theorists would predict. They've noticed that investors would rather accept smaller but certain gains than take their chances to make more money. On the flip side, investors are reluctant to admit defeat and sell stocks that are underwater in hopes of a rebound. As a result, investors tend to sell their winners too early and hang on to their losers for too long.


One way that investors can avoid leaving too much money on the table is to rebalance their portfolios less often. Rebalancing involves regularly trimming winners in favor of laggards. That's a prudent investing strategy because it keeps a portfolio diversified and reduces risk. But rebalancing too frequently could limit your upside. Instead, rebalance only when your portfolio is out of whack with your target allocations. Minor divergences from your targets aren't a big deal, but when your current allocations grow to more than 5 percentage points beyond your original plan, it's time to cut back. To learn more about rebalancing your portfolio, click here.


You also shouldn't be afraid to sell a loser because it will turn a paper loss into a real one. Hanging on to a dog in hopes of breaking even is a bad idea because you may be forgoing a better opportunity. The trick is knowing when it's time to cut bait. That's why it pays to have clear reasons in mind for your purchase of any investment right from the get-go. If your expectations don't pan out, then it's time to sell.

It's All about Discipline

Fortunately, you don't have to be a genius to be a successful investor. As Berkshire Hathaway chief and investor extraordinaire Warren Buffett said in a 1999 interview with Business Week, "Success in investing doesn't correlate with IQ once you're above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing." It's true that not everyone is gifted with Buffett's calm, cool demeanor. But challenging yourself to avoid your own worst instincts will help you reach your financial goals.


Christopher Davis does not own shares in any of the securities mentioned above.



http://finance.yahoo.com/news/Dont-Make-These-Three-ms-13780451.html

Whose recession is this, anyway?

Whose recession is this, anyway?
For some people, bargain prices and new workplace advantages make the economic downturn a time to profit.
By Catherine Holahan, MSN Money

Stephen Lasher reads all the dire economic forecasts declaring this recession the most worrisome since the Great Depression. But life doesn't seem so bad to Lasher. In fact, his horizons have never looked brighter.

Last year, the 33-year-old Columbia Business School grad landed a great job at media company NBC Universal. Now his spending money stretches further than before, thanks to retail store sales. Last month, he closed on his first home: a one-bedroom waterfront condo in a complex with a gym, pool and doorman.

"I am feeling good," Lasher says. "The housing prices were out of control before. . . . Now I was not only able to get a good price, but I was also able to get a mortgage interest rate well below what I thought would have been possible."

Lasher's neighbor James Tortorella agrees that the recession has afforded him some opportunities. He bought his condo in November. "I found a great deal," says Tortorella.

Scoring a bargain condo

So the economic crisis isn't hurting all Americans.

True, the combination of plummeting home prices, steep stock declines and rising unemployment has proved disastrous for many, particularly those new to the job market or nearing retirement. Nationwide, unemployment reached 6.7% in November, according to a Dec. 5 report from the U.S. Bureau of Labor Statistics. The rate jumps to more than 11% when the bureau adds workers who have ceased looking for employment and former full-time employees forced to reduce their hours.

No jobs for grads?

But the same weakness in the economy has helped others, providing many young and midcareer professionals with new purchasing power and giving some a boost up the corporate ladder.
"Middle-career people have the opportunity to do things they were never given exposure to before," says Kathleen Downs, a recruiting manager at Robert Half International, one of the world's largest business staffing and consulting firms. As companies trim their staffs, she explains, midcareer people get an earlier shot at jobs once held by more-expensive, more-experienced workers.

"It's a good time to be positioning themselves," she says of the younger workers.
For people with relatively secure jobs and cash in the bank, it's also a good time to shop. The Consumer Price Index, a measure of the average price of common household goods purchased by urban consumers, fell 4.4% in the past three months, according to the Bureau of Labor Statistics. In that period, transportation costs fell more than 26% because of steep fuel price declines. Apparel dropped prices 2.4%. Year over year, the S&P/Case-Schiller home price index is down 16.6%, according to data released Nov. 25.

Lasher -- and doubtless many like him -- see the price declines as a welcome dose of reality, placing homeownership, vehicle purchases and even blue-chip company stock within reach of a new generation.

"I personally was waiting for a market correction," he says.

Price drop puts homes within reach

Welcome, indeed. A year ago, Lasher was ready to give up on the idea of owning a home near his New York City job. The going rate for one-bedroom condominiums near the city was simply too high.

"I thought I was going to have to move farther away from New York City," Lasher says.
But as the housing market got worse, things got better for Lasher. In recent months, condominiums on the New Jersey side of the river, once prohibitively expensive, began to look affordable. Lasher watched as prices fell about 25% from their peak.

He had been renting an apartment near the New Jersey commuter ferry on the Hudson River, but in November, he pounced on a one-bedroom condo at The Hudson Club, a waterfront complex overlooking Manhattan and just a short walk to the ferry. He locked in a fixed-rate mortgage at 5.875% interest. Lasher isn't discussing precisely what he paid, but here's an idea: a two-bedroom condo in the same complex is now listed for sale at $569,000.

"I don't expect 20, 30 or 40% increases," Lasher says of the condo's value. But he is confident that the purchase price makes his unit a good investment for the future.

Lasher knows he and his peers are not immune to the effects of recession. Some business school buddies who went into the banking business have been laid off.

The national statistics confirm that midcareer professionals have not escaped the downturn unscathed. Unemployment for people ages 25 to 34 rose to a 10-year high of 6.9% in November. That's up from 4.7% a year earlier. Employees ages 35 to 44 also saw record, albeit lower, unemployment rates: 5.4% in November, compared with a 3.5.% rate 12 months earlier. Those figures don't include the more than 33,000 additional job cuts announced this December.

As companies lay off more-senior employees, many midcareer workers are forced to assume additional management responsibilities without receiving pay increases.

"What we are not seeing is the pay increases that would often come in a very strong economy," says Robert Half's Downs.

It may be quite a while before those pay increases return. Consumer spending rose just 2.6% in 2007 from the previous year, according to Bureau of Labor Statistics figures released Nov. 25. Though spending kept pace with inflation, growth was significantly weaker than the 4.3% seen a year earlier. And consumer confidence is still near record lows, though it has risen slightly from its worst levels, according to The Conference Board. A majority of consumers still rate business conditions as "bad" and jobs as "hard to get."

Hard to gain entry at this level

That's how Andy Fisher sees the situation. Fisher is a New York University senior majoring in journalism and history. He thinks his future employment prospects are far less certain thanks to the downturn. Entry-level journalism and publishing jobs seem scarce, he says.

"I am currently in an internship, and, if anything, they are firing, not hiring," Fisher says. "The chances of getting a job at the publishing houses I had hoped to work for seem pretty slim."
In terms of unemployment rates, the recession is hitting recent and soon-to-be college grads hardest. Nearly 11% of 20- to 24-year-olds were unemployed in November, according to the statistics bureau. That's up from 8% a year ago. The increase is due to hiring freezes at major companies and slowdowns at large employers such as Google. It doesn't help to have a glut of older, more-experienced workers in the marketplace willing to downsize careers in return for a steady income.

"It is pretty safe to say that all levels of hiring have slowed," says Michael Erwin, a senior career adviser for online job site CareerBuilder.com.

The recent grads who do land jobs find the process is taking longer. On average, recent college grads are searching an additional six weeks before securing a job, compared with last year, according to a recent CareerBuilder study. Erwin recommends that students set to graduate in the spring begin looking for jobs now. He suggests graduates be prepared to accept positions in fields other than their preferred field, for less pay than they may have targeted previously.
Fisher is weighing whether he should switch to a different career.

"It's pretty troubling," he says. "I basically just have to hope that somebody will pay me for something and keep myself marketable to as many different fields as possible."

'Experienced' translates as 'expensive'

One bright side for younger workers who obtain jobs is they are less likely targets for layoffs. The same can't be said of older workers. In this recession, businesses facing cuts are more likely to buy out or fire expensive, experienced workers whose total compensation, including salaries and health care costs, is more material for the bottom line.

"One way that people try to trim down their work force is by buyouts -- it is usually a first resort for companies trying to shed workers," says Andrew Eschtruth, the communications director at Boston College's Center for Retirement Research.

Buyout offers can present tough decisions for older workers whose retirement savings have been depleted. Many older workers now think they have no choice but to remain on the job and try to rebuild their resources, says Steve Sass, the associate director at the Center for Retirement Research and a co-author of "Working Longer: A Solution to the Retirement Income Challenge."
Sass suggests that even conservative investors -- those who had only 30% of their nest egg in the stock market -- are now contemplating losses of 10% to 15%.

"If you had to save to cover that loss, it is enormous, and it is pretty onerous," Sass says. "If you had to work to overcome that, you're talking another year and a half to two years."

The unemployment rate for workers ages 55 to 64 rose to 4.6% in November. That may sound OK compared with the rates affecting younger workers, but it's a 70% increase for that group from a year ago.

"Previous recessions tended to hit younger workers hard and not so much for older workers," says Richard Johnson, a principal research associate for retirement issues at the Urban Institute, a nonprofit think tank in Washington, D.C. "But what we're seeing this fall is a rather steep increase in the unemployment rate for those 55 and older and those 65 and older."
Employment professionals are all about opportunity, so they try to put a positive spin on all this. They suggest that, for now, employers are in the driver's seat, able to lay off workers and keep salaries down. But their leverage will vanish when the economy turns around, and the leverage will pass to employees who have added responsibility during the downtown with no significant increase in salary. When that happens, it's time to ask for a fat raise, they say.

"There is some light at the end of the tunnel," CareerBuilder's Erwin says.

Produced by Darragh Worland
Published Dec. 5, 2008

http://articles.moneycentral.msn.com/Investing/StockInvestingTrading/Whose-recession-is-this-anyway-msnmoney.aspx?page=all

Under 50? Do This, or You'll Regret It!

Under 50? Do This, or You'll Regret It!
By John Rosevear December 8, 2008 Comments (1)

I know, I know -- the stock market is crazy and unpredictable right now.

I know that sitting in cash or doing nothing until things settle down seems like a sensible course of action.

But I also know this: 10 or 15 years from now, the market will be up. Way up from here, in all likelihood.

If you're under 50, and you're trying to figure out what to do with the wreckage of your retirement portfolio, there's only one good answer: Buy great stocks.

Here's why.

When the game is rigged, bet with the house No, the stock market isn't "rigged" in the sense of being manipulated. It is, however, inherent in the market's nature to go up over the long term, scary bear markets notwithstanding.

Check out these 15-year returns, which assume purchase on Dec. 8, 1993 and include reinvested dividends for those stocks that have them:

Stock-----15-Year Gain

McDonald's (NYSE: MCD)
430%

Apple (Nasdaq: AAPL)
1,110%

Southern Company (NYSE: SO)
804%

Nokia (NYSE: NOK)
541%*

Qualcomm (Nasdaq: QCOM)
1,945%

Johnson & Johnson (NYSE: JNJ)
573%

Target (NYSE: TGT)
612%

Source: Yahoo! Finance.
Figures as of market close on Dec. 5, 2008. *Nokia return since Apr. 25, 1995.

Those returns are despite the dot-com bubble bursting and despite the recent market crisis. As Richard Ferri, an investment manager and author of several books on asset allocation and indexed investing, argues in this month's issue of Rule Your Retirement, there are strong reasons to believe that the market is naturally prone to going up over time -- and that average annual returns near 10% over the next 15 years are extremely likely.

His methodology and reasoning are a little too elaborate to lay out here -- check out the complete article for specifics -- but his recommendations for those under 50 are crystal-clear:

• Your portfolio should be 100% in stocks.
  
• Continue to add to your retirement accounts, and use that money to buy stocks.
  
• Be aggressive -- as aggressive as you can stand.
  
• Ignore performance. Don't look at your statements.
  

That last one might seem weird -- how will you know how you're doing if you don't look at your statements? -- but Ferri has a point. He argues that they're "completely irrelevant" -- following short-term price movements just doesn't give you any useful information. In fact, it's more likely to give you something to worry about, needlessly.

I'd add this caveat: This only works if you have very long-term investments! Not all portfolios are built to run 15 years or longer with no more maintenance than the occasional trade or rebalance -- in fact, most aren't.

How do you do that?

Construct a long-haul portfolio

Ferri is a proponent of indexing -- of using index funds and ETFs in your retirement portfolio. That’s one way to build a long-term investment strategy. Another way, one likely to yield far greater returns if done right, is to buy great stocks -- the blue-chip dividend monsters and future giants that will keep delivering rewards year after year. (Can you guess which method I favor?)

Of course, "buy stocks" isn't a complete to-do list. To maximize your gains over the long haul, you need a solid asset-allocation plan -- one that gives you exposure to all the key corners of the stock market. Your 401(k) provider can probably help you come up with a decent one -- though as a rule, those computer-generated templates tend to be more conservative than is appropriate for most young investors.

A far better set of asset allocation roadmaps for retirement investors -- one of the best I've seen, and one that works well whether you're using mutual funds in a 401(k) or stocks in an IRA, or a combination of the two -- are the ones maintained by the team at Rule Your Retirement. They're available to members by clicking on "Model Portfolios" under the Resources tab after you log in.

What do the unfolding financial crisis and ongoing market volatility mean for your money? The Fool's here with answers. Fool contributor John Rosevear owns share of Apple. Southern Company and Johnson & Johnson are Motley Fool Income Investor selections. Nokia is a Motley Fool Inside Value pick. Apple is a Motley Fool Stock Advisor recommendation.

http://www.fool.com/personal-finance/retirement/2008/12/08/under-50-do-this-or-youll-regret-it.aspx

Value Investing: A Philosophy More Than a Formula

Value investing is based more on philosophy. Those who studied directly under Graham are careful to explain that Graham and Dodd's Security Analysis and Graham's The Intelligent Investor are not cookbooks for the investment professional. There is no step one, step two, and step three. Graham's purporse was to make his students use the deductive process to think for themselves.

Despite continual examination, questioning, probing, and tweaking of the Graham and Dodd concepts, the very basics - the fundamentals - remain intact.

Three Key Concepts

When Warren Buffett talks about his training under Graham, he says that the two most important things he learned at Columbia University were:

• The right attitude
• The importance of margin of safety

By listening to Buffett speak and by reading Berkshire Hathaway's annual reports, a third key Graham concept surfaces repeatedly, that of

• Intrinsic value.

Market Manipulation

Charles Dow wrote in 1901: "The manipulator is all-powerful for a time. He can move market prices up or down. He can mislead investors, inducing them to buy when he wishes to sell, and sell when he wishes to buy; but manipulation in a stock cannot be permanent, and, in the end, the investor learns the approximate truth. His decision to keep his stock or sell it then makes a price independent of speculation and, in a large sense, indicative of true value."

In the current regulatory situation, manipulation, though it does crop up, is less common.

Also read:
Stock Market Manipulations
25 Nov 2008 BURSA MALAYSIA SECURITIES BERHAD REPRIMANDS, FINES AND STRIKES OFF PNEH TEE EONG, A COMMISSIONED DEALER'S REPRESENTATIVE OF M&A SECURITIES SDN BHD FROM THE REGISTER FOR VIOLATION OF RULES 404.3(1)(a) & (b) AND 401.1(2) & (3) OF THE RULES OF BURSA SECURITIES

Five tips for buying stocks in bad times

WEEKEND INVESTOR
How to outsmart a not-so-average bear
Five tips for buying stocks in bad times

By Jonathan Burton, MarketWatch
Last update: 7:01 p.m. EDT Oct. 17, 2008

SAN FRANCISCO (MarketWatch) -- You survived the stock-market crash of 2008. Congratulations. Now comes the hard part: Buying stocks and mutual funds that can survive -- and even thrive -- in the bear market.

Buying in a bear market? That's what Warren Buffett is doing. The famed investor was blunt about why: "Be fearful when others are greedy, and be greedy when others are fearful," he wrote in an opinion piece Friday in The New York Times. "Bad news is an investor's best friend," he added. "It lets you buy a slice of America's future at a marked-down price." Read Buffett's editorial.

The key, as always, is what you buy and how patient you are. Buffett isn't banking on a quick turnaround; he knows that patience is rewarded. You can average in to stocks over time -- there's no reason to back up the truck. Markets are bracing for another shock: the specter of the first consumer-led recession in almost two decades.

"This volatility is signaling the end of an era," said Rich Bernstein, chief investment strategist at Merrill Lynch. "If you're picking stocks or looking for a fund, the characteristics you want are the ability to continue to enhance shareholder value. Think of it in terms of companies that are self-funding. Look for companies that have excess cash flow."

Let that be your bear-market investing guide. You want an investment portfolio of high-quality stocks and mutual funds that not only can weather this economic storm but come through it stronger.

That naturally steers you to traditionally defensive consumer staples and health-care companies, but don't limit yourself. There will be opportunities in other sectors, but the new leaders, regardless of their business, will demonstrate the financial strength and self-sufficiency to flourish in what will be an increasingly Darwinian market.

So think like an acquirer; think like Buffett. Keep the following five criteria uppermost in mind when you evaluate a stock or the companies in a fund's portfolio:

1. Free cash flow
Free cash flow is essentially a company's budget surplus. Excess cash -- not earnings -- is for many investors the true measure of a company's flexibility because unlike earnings, cash flow is tough to fudge with accounting tricks.

"Look for strong and growing free cash flow," said Rob McIver, co-manager of Jensen Portfolio (JENSX ) . "Cash flow is harder to manipulate than earnings per share."

To calculate free cash flow, take net income plus amortization and depreciation, minus changes in working capital and capital expenditures. Companies with excess cash have options. They can invest in the business or make acquisitions, and give investors a boost by increasing dividend payments and buying back shares.

Many of the 28 stocks in the Jensen fund are large-cap consumer goods and health care companies fitting this bill. Top holdings as of Sept. 30 included medical-device giant Stryker Corp. (SYK) , pharmaceutical leader Abbott Laboratories (ABT) and consumer products titan Procter & Gamble Co. (PG) . The fund also has a newer position in software developer Cognizant Technology Solutions (CTSH) .

Said McIver: "There's a place in everyone's portfolio for high-quality companies where predictability and sustainability of earnings is valued."

2. Little or no debt

The most profitable areas for much of this decade -- real estate, energy, financials, commodities, emerging markets -- all benefited from cheap and easy credit. Now credit is not readily available and not so cheap. Accordingly, credit-sensitive sectors are underperforming.

"Companies that are levered or need to tap the capital markets are going to struggle in terms of being able to get financing at a reasonable price -- or at all," said John Buckingham, editor of The Prudent Speculator newsletter and manager of the Al Frank Fund (VALUX) .

Concentrate on companies that can finance their own growth and have low debt as a percentage of total capital. Organic growth, as opposed to growth through acquisition, is also crucial.
"Focus on balance sheet strength," Buckingham said. "We like Microsoft (MSFT) because it doesn't need to tap the capital markets." Big blue-chip technology companies such as Cisco Systems Inc. (CSCO) and Oracle Corp. (ORCL) "are excellent places for investors," he added.

In a market where cash is king and earnings predictability is paramount, Buckingham is also bullish on big pharmaceutical companies including GlaxoSmithKline Plc (GSK ) and Merck & Co. (MRK) and health insurers Aetna Inc. (AET) and Humana Inc. (HUM)

"The important thing," Buckingham said, "is does the company have the ability to navigate the difficult environment we're in or does it have to go to the markets for capital, and the markets are not exactly friendly right now."

3. Strong market share

Companies involved in basic businesses with a national or global footprint, or that help other companies be more productive have a competitive advantage in a miserly market. Marshall Kaplan, senior equity strategist with Smith Barney Private Client Investment Strategy, uses the example of oil service companies that can charge a premium for extracting oil and gas, or technology companies that make it easier to process data.

"Ask yourself, is it a viable franchise?" Kaplan said "Are you talking about products and services that are going to be needed not for brief periods but over the long term? Is the quality of earnings there? You've got to make sure you're in a situation where the business can be maintained at levels that are conducive to growth."

Stocks on Smith Barney's recommended list that meet this criteria include Apple Inc. (AAPL) , ConAgra Foods Inc. (CAG) , Johnson & Johnson (JNJ) , Kimberly-Clark Corp. (KMB) and National Oilwell Varco Inc. (NOV)

"It's tough for the individual investor to keep his or her head about them in a market like this," Kaplan said. "These types of names create a stronger level of support. The days of buy-and-hold, one-decision stocks are gone, but you could have a longer holding period in the names with these characteristics."

4. Solid management

Companies in top financial shape have management that's proactive and capable.

"Honorable," is how McIver, the Jensen fund manager, puts it.

"Understand what creates and what destroys shareholder value," he said. "You can't run a company from quarter to quarter to meet earnings targets. You have to make long-term decisions and capital expenditure decisions that will reap rewards."

The Jensen fund won't invest in a company until the managers visit executives on their home turf. Moreover, these corporate chieftains must have delivered return on equity -- net income divided by shareholders' equity -- of at least 15% annually on average for 10 consecutive years. One slip, and the stock is booted from the portfolio.

"By knowing the companies well, we can minimize business risk," he said.

5. Attractive valuation

Investors have tossed out stocks in panic, including those with strong fundamentals. Market sentiment is mired somewhere between despondency and ye of little faith.

But many professionals are taking a page from Buffett. "I'm looking for stocks that are already cheap," said Tom Forester, manager of Forester Value Fund (FVALX ) , which counts consumer goods leaders H.J. Heinz Co. (HNZ) , Kraft Foods Inc. (KFT) and Johnson & Johnson among its top holdings. "They tend to have a lot less downside, but they also have plenty of upside potential."

He's also finding bargains in technology. "I'll buy Microsoft at 12 times earnings," Forester said. "For a tech stock it's very cheap. I like the cash, the stock buybacks, and revenue streams are steady."

Buckingham's picks include General Electric (GE ) , United Technologies (UTX) and IBM (IBM) . "There's a lot of opportunity in large-cap stocks right now," he said, "and arguably you've got a greater margin of safety."

In this market, investors will need the margin of safety that a low price brings. The crash was just the end of the beginning. Now comes what could be many months of head-fakes and hopeful rallies that wind up in dead ends. You'll be Charlie Brown charging the football with head held high, only to land flat on your back.

While it won't make the challenges any easier, take to heart what veteran stock analyst Bob Farrell noted in his iconic 10 "Market Rules to Remember": Bear markets, he wrote, have three stages -- "sharp down, reflexive rebound, and a drawn-out fundamental downtrend." See related story.

Where it stops, nobody knows, but a portfolio with strong defensive stocks stands a fighting chance.

Jonathan Burton is an assistant personal finance editor for MarketWatch, based in San Francisco.

http://www.marketwatch.com/news/story/you-can-buy-bear-market/story.aspx?guid=%7b61CFDC64-F688-4C93-8C88-010A83AEECF0%7d&print=true&dist=printMidSection

50%-50% versus 80%-20% portfolio blend of stocks and bonds

It's all in the mix
How to invest well and sleep better, in good markets or bad

By Jonathan Burton, MarketWatch
Last update: 6:37 p.m. EST Nov. 18, 2008
Comments: 58

SAN FRANCISCO (MarketWatch) -- In this devastated market, "risk tolerance" is an oxymoron. Those little tests the online investing sites give you to assess how much risk you can handle in your investments don't do justice to the kind of crash we're living through.

Most of us can't stomach 40% free falls in our fortunes and we certainly can't -- or don't want to -- suffer a shellacking like the one we had in October and then watch what's left trickle away.


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You don't have to.

This may be too late for many investors who have already seen their stock-heavy nest eggs scrambled, but some research and simple number-crunching indicates you can keep less money invested in stocks than conventional wisdom would have you believe -- without giving up your retirement goals and with a lot less risk.

Indeed, a portfolio that mixes 50% stocks and 50% super-safe long-term Treasury bonds has performed almost as well over the past two decades as a portfolio that carries an 80%-20% blend of stocks and bonds. And if you're the guy holding the first portfolio, you're probably sleeping a lot better these days than the other fellow.

"If your goal is to be very confident about having a certain amount of money at a point in time, lower-risk portfolios are actually a cheaper way to get there than a higher-risk portfolio," says Christopher Jones, of Financial Engines, an investment advisory firm.

If you, like many investors, have bailed out of stocks this year, you have, unfortunately, sold into the collapsing market and locked in your losses. But who could blame you? Most people can't handle the pain this market is inflicting. And the losses are worse because people nearing retirement often end up with way too much of their portfolios in stocks as they try to goose growth in their twilight working years.

The typical investor's thinking goes something like this: Stocks over time outperform both bonds and cash. So without a high allocation to stocks, you'll fall short of your financial goal, inflation will ravage your portfolio and your golden years will be tarnished as your money runs out before you do.

Big problem: The 80% or 70% stock portfolio that served you well in your 20s or 30s bites back in your 50s and 60s, when a crash erases years of growth in just a few weeks or months.

Start with a balance

There has to be a better, more automatic way to build wealth without constantly refiguring your investment mix. There is. Forget the stock-heavy plan and start with an equal balance of stocks and bonds.

Let's look at what happens when you ratchet down stocks early to a less volatile level: We asked investment researcher Morningstar to calculate your investment results if at the end of October 1987 -- a really frightening moment, right after the big crash that year -- you had put 50% of your money in a low-cost fund that mimicked the Dow Jones Industrial Average ($INDU:
Dow Jones Industrial Average) and 50% in a vehicle that mirrored long-term Treasurys.
Nowadays that could be accomplished at a low cost using the Dow "Diamonds" exchange-traded fund (DIA: Dow Diamonds ETF) and iShares Lehman 20+ Year Treasury Bond ETF (TLT:
iShares:Lehm 20+ Trs) . Over the decades, you would keep the allocation constant through annual rebalancing and would reinvest all stock dividends and bond income.

'Good enough' returns

The plan is to smooth your investment performance, accepting lesser short-term gains in exchange for milder, and less worrisome, short-term declines.

In this most recent 21-year example, by October of this year a 50%-50% portfolio would have averaged a 10% annual return and you would have insulated yourself from a significant portion of the market's day-to-day risk. Your best quarterly performance? A 13.8% gain in the value of your portfolio. Your worst? A 9.1% loss.

By comparison, a portfolio of 80% stocks and 20% Treasurys would have been exposed to considerably more market risk, but your return would average just a slightly better 10.3% a year. Your best quarterly performance would have been an increase of 17.6% in your portfolio while your worst would have been a 14.2% loss.

In the current bear market, the 50%-50% portfolio would be down about 14.6% from the October 2007 market peak through the end of last month, while the 80%-20% portfolio would be down 24.8%.

Over the 21-year period, the 50%-50% portfolio would have achieved 95% of the total dollar return of the 80%-20% mix, with substantially lower risk, a steadier performance and, for you, many fewer sleepless nights.

Not much difference

Make no mistake. The 50%-50% portfolio will leave you poorer than the riskier blend. But the difference isn't that substantial.

Had you put $25,000 into the 80%-20% split in 1987 and never invested another dime, the money would have grown to about $196,000. That same amount in the 50%-50% blend would be worth around $185,000.

The strategy holds up if you dollar-cost average, too, and invest a little at a time over the years. Add $100 a month, and $25,000 grows to $261,621 in the 80%-20% portfolio and $251,732 in the 50%-50% mix.

And even if you eliminate the market's horrendous decline over the past year from the calculations, the conservative plan still performs admirably. At the market's peak in October 2007, the 80%-20% portfolio would have been worth $261,109, while the 50%-50% split would have grown over that 20-year period to $217,222, capturing 83% of the more aggressive approach's return, but with far fewer bumps.

Of course in bull markets, you won't make as much with a 50%-50% portfolio. You'll give up bragging rights. But you also won't feel the raw fear that others do during the inevitable downturns. That should be worth a few thousand dollars right there.

Jonathan Burton is an assistant personal finance editor for MarketWatch, based in San Francisco.

http://www.marketwatch.com/news/story/how-invest-well-sleep-better/story.aspx?guid=%7BA27C214B%2DE1CE%2D4990%2D907C%2D67D1338851AC%7D#comments

Advice on China investment: Follow the government

CRAIG STEPHEN'S THIS WEEK IN CHINA

Advice on China investment: Follow the government
Commentary: Talk of yuan convertibility illustrates why official statements and media may be key for making money
By Craig Stephen

Last update: 4:10 p.m. EST Nov. 23, 2008
Comments: 11

HONG KONG (MarketWatch) -- If you want to invest in China, do not try to pick winners among businesses. Instead, follow government policy.

That was the advice given by one seasoned China private equity investor speaking last week at Hong Kong's annual Venture Capital Forum held at Cyberport. To be honest, I had expected some secret investment recipe from these sage professionals, who invest early for the longer term.

There was more: Read the Peoples Daily carefully, as it often front-runs government policy to gauge opinion.

This advice might seem disarmingly straightforward, but it makes a lot of sense. Let the government anoint the winners and jump along for the ride, be it China Mobile (CHL:
china mobile limited) or Alibaba (ALBCF: alibaba com limited) (HK:1688: news, chart, profile) .

For the future, a couple of sectors at the Forum were highlighted as getting special attention from Beijing, namely health care and clean tech.

Some brokers agree that following the government is a sensible investment strategy. MainFirst, in a new report, says earnings visibility is scarce and the simplest path is to see which sectors benefit from the Chinese government's monetary and fiscal stimulus.

This looks like a timely updates of the "buy what China is buying" strategy. After all, in these cash strapped times it seems only governments have money to spend.

Another way to follow this advice is to watch the mainland Chinese government's external policy. China looks set to assumes a bigger role on the world financial stage, possibly sooner rather than later. Increasingly Beijing is debating policy options as it surveys the damaged financial landscape in the post sub-prime era.

Last week the sacred cow of the yuan currency and its lack of convertibility appeared to leap back on to the policy agenda after being run in the press.

A former deputy governor of the central bank called for China to accelerate moves towards convertibility of the yuan. Wu Xiaoling, now a deputy director with the finance and economic committee of the National People's Congress, said China must move soon.

China's currency today has a crawling peg to the U.S. dollar but is still not fully convertible. It may be bought and sold for purposes of trade and investment, but it's not convertible for purely financial transactions.

This arrangement had been credited with shielding China from the worst of the financial crisis. But as times change, it might also be time for a policy rethink.

The main arguments against change are fears of capital flight, unpredictable moves in the exchange rate, and preserving the value of China's U.S. dollar reserves.

As China recently surpassed Japan as the biggest holder of U.S. government securities, it could be timely to question the wisdom of adding to its mountain of dollar reserves, especially with U.S. authorities looking set to print more greenbacks as more businesses demand a bail out.
Wu was reported to say China's foreign reserve and commercial banks hold US$370 billion of Freddie Mac and Fannie Mae bonds, but that should not stop change -- China could afford to lose that.

Worries convertibility could spark capital fleeing China's shaky institutions should be less of an issue today: They surely stack up a lot stronger against their beaten-down overseas counterparts.

Against that, the benefits of having a fully convertible currency have to be considered. It should be easier to trade in yuan, with contracts in yuan removing a lot of exchange risk. There is also potential to boost growth in China's banks and financial institutions as they diversify.

Not only could China seek to have more diversified foreign reserves, it could also benefit when other countries' central banks hold yuan reserves -- something Thailand recently proposed.
Other media reports suggest China is considering adding more gold to its reserves. Gold is well off its dollar-denominated highs, but it has recently held up pretty well as a store of value in euros and many other currencies.

If China does move, or if it begins the process, it will have major implications for reserve currency weightings, as well as potentially for the Hong Kong dollar, and will lead to increased capital flows.

Of course, the proposal may be merely testing opinion, but it is something to keep an eye on.
Meanwhile, in Hong Kong as the economy continues to decline, some analysts suggest that, here too, government intervention is possible. RBS said in a new research note that the government could intervene to shore up the property market if price falls accelerate, warning of a return of asset deflation.

Hong Kong Chief Executive Donald Tsang recently held a fireside chat with British Prime Minister Gordon Brown, so maybe RBS has a fast track on information. The U.K. government will shortly become the largest shareholder in RBS, in the new world of state-owned investment/commercial banks.

It seems everywhere, we will have to get used to more government intervention in the economy.

And as the balance of power shifts on the global stage, being prepared for Beijing's next moves is going to be increasingly important


http://www.marketwatch.com/news/story/china-investors-its-all-about/story.aspx?guid=%7BC6C3074C%2D7F00%2D40DB%2D8F55%2D6E5303B13CDC%7D&dist=morenews

Optimism fades on the mainland, but watch for pockets of growth

CRAIG STEPHEN'S THIS WEEK IN CHINA

Chinese caddies join the unemployment line
Commentary: Optimism fades on the mainland, but watch for pockets of growth
By Craig Stephen
Last update: 4:14 p.m. EST Dec. 7, 2008
Comments: 1

HONG KONG (MarketWatch) -- Keeping track of the widening casualties of the global recession in China is becoming increasingly difficult, but it is still worth watching for pockets of opportunity.

Put deflating asset bubbles, steep interest-rate cuts and a 4-trillion-plus yuan stimulus package into the mix, and you can expect a lumpy economy at best.

In recent weeks, China has gone from optimism it could escape the global slowdown to a realization its export sector would take a direct hit -- November exports are expected to have shrunk in value for the first time in seven years -- and finally, to worries the whole economy is on the floor.

J.P. Morgan, in a new strategy note, pinpoints the "collapse of the domestic housing market" for spreading the feel-bad factor around.

Leaving aside the export sector, it seems intuitive that many of the industries that fed off the asset and property bubble on the way up will be spat out on the way down. One surprising new casualty of the economy is the jobless golf caddie.

http://www.marketwatch.com/news/story/story.aspx?guid=%7B95225E19%2DC6BE%2D4EF8%2DBE83%2DF7C851A6873D%7D&siteid=rss

A Leading Bear Turns Bullish, Sort of

SATURDAY, DECEMBER 6, 2008
INTERVIEW

A Leading Bear Turns Bullish, Sort of
Barry Ritholtz, CEO and Director of Equity Research, FusionIQ
By ROBIN GOLDWYN BLUMENTHAL

AN INTERVIEW WITH BARRY RITHOLTZ: Getting ready for a "significant" rally.

FOR THE PAST FIVE YEARS, BARRY RITHOLTZ HAS BEEN entertaining, educating and elucidating readers of his blog, The Big Picture (http://bigpicture.typepad.com/). Among the noteworthy calls that the savvy lawyer and sometime-trader has made: identifying a credit bubble a few years ago, and a recommendation to short AIG back in February, when the share price was flirting with $80; it's now about $1.80.

Chris Casaburi for Barron's

"There's upside here for a trade. Over the past 100 years, we've only seen the relative strength of the S&P 500 drop to this level five times…Each time, it has been a major buying opportunity, although not necessarily a major bottom." –Barry Rithotlz

Lately, the 47-year-old Ritholtz, with his business partner, Kevin Lane, has had a chance to put some of those ideas to work at FusionIQ, a firm that manages nearly $100 million in separate accounts. Amid the wholesale destruction on Wall Street, Fusion has produced single-digit gains on its long-short portfolios, and has kept the average losses on its long-only accounts to single digits. Ritholtz, whose book Bailout Nation is due early next year from McGraw-Hill, can be trusted to call 'em as he sees 'em. To find out what the contrarian is now warming up to, read on.
Barron's: What's your global outlook?

Ritholtz: In 2006, I was probably the most bearish guy on the Street; now at a table of industry people, I'm the bullish guy. We've cut this market in half; that doesn't mean it can't go lower. We're in a medium recession. If this turns into a deeper, more prolonged recession, all bets are off.

Are we are testing a real low here?

There's no doubt we're looking at an extremely oversold market. But by the end of the week, that oversold condition could be worked off. There's upside here for a trade. Over the past 100 years, we've only seen the relative strength of the S&P 500 drop to this level five times, and each time, it has been a major buying opportunity, although not necessarily a major bottom. If you look at 1929, it was a low but it wasn't the low, and there was a bounce. It was the same thing after Sept. 11 -- from Sept. 21, you had a 40% bounce in the Nasdaq before you went down to make all-time lows.

Will the market drift?

It's flapping up and down. There is a significant rally, 20% or 30%, waiting to happen. But there's also the possibility of a lower low, as we get deeper into the recession, if things take a terrible turn for the worse.

Whenever you're fragile, you don't have the ability to absorb that next blow. My fear is that some economic issue arises and you don't have the resiliency to deal with it. We're economically stretched very, very thin. Things seem to be getting healthier at an ungodly cost, one which we will be dealing with the unintended consequences of for decades. We're really at the fork in the road. Everybody on Wall Street is wondering if we're going to see a year-end rally of any substance, or, if we're heading down to 7100 on the Dow, or 850 on the Nasdaq. [On Friday, those indexes were at about 8200 and about 1430, respectively.]

What say you?

We're waiting for a couple more things to line up: Some clarity on earnings, which we won't have for a while, some sort of resolution on these bailouts, and some sign from the new administration that, unlike the outgoing group, we have a plan -- "Here's what we're going to do about credit, banks, the economy, GM." We wouldn't be surprised to see earnings seriously damaged.
Wall Street is still way too high. They started out the year at earnings of $103 a share on the S&P 500 for 2008, which got them to 1600 on the index. We came in at $65 a share, and that may have been too bullish. The good news is that most of corporate America outside of the financial sector has healthy balance sheets, lots of cash, and is running very lean.

Except for the auto industry.

The auto industry is a whole other story. The auto industry is a story of terrible management, misguided unions, and government intervention.

What's your impression of the bank bailout?

[Treasury Secretary] Hank Paulson is really the imperfect messenger for this bailout. Remember that Paulson is one of the five executives who went to the SEC in 2004 to beg, 'Please, let us lever up more. Please let us go to [a leverage ratio of] 30 or 40.' It is bad enough that he helped create the crisis. It appears that this whole response is completely ad hoc.

Do you see any guiding principle?

It is, how do you give money to banks who need capital and not say, 'By the way, you're cutting your dividend.' What's happening instead is they're saying, 'Here is money: Give it out as dividends and bonuses.' It is unbelievable. There is no clawback. It is unconscionable.
So, what does it take to invest in this kind of world? How do you stay out of trouble?

We have a number of internal rules. The most important is that we always have a stop-loss. When the trade is working out, we use trailing stop-loss, meaning that the higher the stock goes, the higher the stop-loss. When the market starts heading south, we get taken out. We screen for short squeezes, and we've found that they're very often present at the beginning of a major move up.

We back-tested [price/earnings ratios] and found they have no forecasting ability. Whenever people do an analysis of a stock, the tendency is to create a snapshot at a given moment. We try to build a moving picture of a stock. For instance, if you know you're in an all-time peak in home sales, and the Fed is in a tightening regime, why own a stock in a homebuilder?

The builders have been pretty beaten down, though.

I've been the biggest bear on housing on the Street for four years now. Housing is halfway through. We're not even close to the bottom in housing. The stocks were always cheap, so it's not a valuation question.

Given the uncertainty in the market at large, what appeals to you right now?

We've been trading the two-to-one leveraged [exchange-traded funds].

One is the Ultra S&P ProShares [ticker: SSO] -- for every dollar the Standard & Poor's 500 moves, it moves two dollars. And there's also Ultra Triple Q ProShares [QLD], the Nasdaq 100-version of the SSO. The flip of the QLDs are the QIDs, which are the negative two-for-ones on the Nasdaq. We're starting to look at that. We are now running about 70% cash, which is inordinately high, but some of the names we're watching, and have owned in the past, are NuVasive [NUVA], a medical-device company, Stanley Works [SWK], a great infrastructure story, LG Display [LPL] and Luminex [LMNX]. Industries we like are infrastructure, defense, biotech and medical devices.

Why ETFs?

We're normally bottom-up stockpickers. But when we're looking at all these individual stocks and war-game them, we end up saying there's this risk and that risk. Here's an example: JPMorgan [JPM] is probably the best house in a bad neighborhood. It had a nice run, then it pulled back; do we want to own JP Morgan? What's the risk? They've already acquired Bear Stearns. They have to be looking at Goldman Sachs [GS]. They have to be looking at putting the house of Morgan back together. If that happens, what happens to the stock price of JPMorgan? You could lose 15%, 20% overnight. Every time we look at individual stocks, we end up with that analysis.

We spent a lot of the year running a good chunk of cash. Some of that is discipline; a lot of that is staying away from things that are really trouble. The trade that caused so much trouble for people -- long financials -- we're at the point where some of the financials are starting to look attractive.

Would you give us a name?

Citigroup [C] at $5. The interesting thing about Citigroup is that if there's anything that's legitimately too big to fail, Citigroup is it. If you think the consumer and retail sector are having a hard time, imagine if Citigroup were allowed to go belly-up. People would hunker down in their homes and stop buying all but the necessities.

I didn't really buy that Bear Stearns was too big to fail, although there was the argument that they could take JPMorgan down. Citibank is one of those things that cannot be allowed to go belly-up. It's enormous. It's the equivalent of AIG.

What else do you like?

We like infrastructure, plays like Stanley Works, and we expect there will be some stimulus to build ports, bridges, and expand the electrical grid. Defense is another sector we like, though it's less so of the Boeing s [BA] and more of the specialty-defense names, like AeroVironment [AVAV], which makes small, pilotless drones.

There's a list of interesting biotech and medical-devices companies, which are insulated from the economic cycle. We just bought Cubist Pharmaceuticals [CBST], which addresses the anti-infective market. In the same way the Internet bubble gave rise to Web 2.0, Facebook and blogs, the Genentechs of the world and all the developments that took place throughout the 1990s have led to the current new wave of specialized therapeutics. Over the next 10 years, we're going to see a universe of breakthroughs based on the previous 20 years' work. The first order of business on Jan. 20 [presidential-inauguration day] is allowing stem-cell research, and that's going to lead to a number of significant breakthroughs. Medical devices and gene therapies are ripe areas. The problem is, they're very volatile and very speculative, and not necessarily safe for the ordinary household.

What stocks are you shorting?

We've been short Jefferies & Co. [JEF] for a while. They're similar to the various asset gatherers: In this environment, it becomes very challenging to hold on to key people. The best guess is, they're suffering along with the rest of the sector, only they don't have the strength or the size to do things that a Goldman Sachs or a Morgan Stanley or Wachovia can.
Table: Ritholtz's Picks

What about gold?

Gold is really quite interesting here, as are the gold miners. We own no gold now, and we own no gold mines, but we are watching them. The question is, at what point does this deflationary cycle roll over to the point where things start to get better?

We were among the loudest inflation hawks for the past few years. When oil was $147 a barrel the joke was, which was going to hit $6 a gallon first, premium gasoline or skim milk?

In March, we said we are through the worst part of the inflation cycle and now we should see deflation as the economy starts to roll over. And that is pretty much playing out. The bugaboo with all that is you just had the Fed triple its balance sheet. The Bernanke printing presses are running full speed. That ultimately has to hurt the U.S. dollar; it ultimately has to be inflationary.

Has gold bottomed?

I don't know where gold bottoms. We recommended gold for the first time in 2002 or 2003. It was strictly an inflation trade, thanks to Greenspan. And then when the GLD gold ETF first came out, we recommended that. Gold has a date with $1,500 somewhere in the future [up from $763 an ounce now], but whether it makes that move from 700 or from 400, I have no idea. You just can't print that much paper and debase the currency and not see some sort of reaction.
Anything else look interesting?

We always tell people when things are really good you have to make emergency plans. You know, the time to read that card on the seatback in front of you is not when the plane is heading down. When things are really awful like they are now, that's when you start making your wish list. I have never owned Berkshire Hathaway [BRK], but if it was cheap enough I'd buy it.

A level, please?

$85,000 to $95,000 [versus $98,000 recently].

Where else might you be deploying some of that cash?

One client said to me, "I'm tired of hearing bad news. I don't care what it is, what can you tell me that is good?" I told him to make a list of things he's wanted to own, but has been afraid to buy or unable to because of the cost. I don't care if it is art, trophy properties, vacation homes, collectible automobiles or boats. Figure out what you are willing to pay, and I can all but guarantee you that by the time we are done with this deflationary cycle, many of those objects will be available at your price. I wouldn't be surprised if, when everything is said and done, a lot of these things are off by 50% or worse.

Thanks, Barry.

http://online.barrons.com/article/SB122852213723784245.html?mod=rss_barrons_this_week_magazine&page=sp

How You Can Rebuild Your Wealth

Investments

How You Can Rebuild Your Wealth

History shows that the best way to rebuild portfolios is to stay in the stock market. Over the past nine recessions, the Standard & Poor's 500-stock index has gained 13%, on average, during the second half of a downturn and another 13% the year after it ended.

"This is likely to be one of the best buying opportunities, if not in the last decade, then in the last century," says financial planner Harold Evensky.

Strategists favor cash-rich blue chips in defensive sectors like consumer staples and health care, and technology giants. Exposure abroad also will be crucial to rebuilding wealth. Among foreign markets to watch, veteran global managers cite Japan, China, Brazil and parts of Europe outside the U.K. and Spain. (Both of these countries face their own real-estate woes.)

But it's worth keeping a portion of your portfolio in cash and bonds just in case; planners such as Mr. Evensky are keeping at least 15% in cash for their clients. For now, limit bond exposure to shorter-term, high-quality issues.

Additionally, you can ward off inflation concerns, which many economists expect will re-emerge in a year or two, by purchasing Treasury Inflation-Protected Securities, or TIPS.

http://online.wsj.com/article/SB122862515245785795.html

Mutual Funds: Saner Markets Ahead

Industry Insights

Mutual Funds: Saner Markets Ahead

Michael Maiello 12.05.08, 6:00 AM ET

In the December issue of Dan Wiener's newsletter, "The Independent Adviser for Vanguard Investors," Wiener interviews James Barrow, lead manager for $31 billion Vanguard Windsor II, and learns that the venerated value manager believes that hedge fund liquidations should cease by the end of the year, taking a good deal of volatility and downward pressure out of the markets.

Barrow told Wiener that: "All of that money the banks loaned the hedge funds is getting called in. They are selling these guys out. Not only are these guys getting redeemed by their investors, they're getting redeemed by their lenders. I don't know how long this has to go on--it'll obviously be over by the end of the year, but it could be pretty bloody between now and then."

This served as the topic of this week's mutual fund discussion between Dan Wiener, Adam Bold of The Mutual Fund Store and Richard Gates of TFS Capital. The consensus was that 2009 will bring smoother markets and it's time for investors to prepare for a market, if not an economic recovery.

The Forbes.com mutual fund panelists are:
Daniel P. Wiener, editor of Independent Adviser for Vanguard Investors and CEO of Adviser Investments.
Adam Bold, founder and chief investment officer of the Mutual Fund Store.
Richard Gates, portfolio manager for TFS Capital.

Hedge Funds, Mutual Funds and Volatility

Wiener: Barrow has been around the block many times, and his contacts within the financial community are quite broad, so when he says he thinks the hedge fund selling is about complete I have to think he's on to something. In addition, I have at least one source within one of the big clearing banks that thinks the worst is behind us.

With the last two big recessions (73 to 75, and 81 to 82) having lasted 16 months each, and the current recession now having been date-stamped as starting December 2007, there is some historical precedent for assuming we are at worst midway through the economic crisis. And since we know that markets are discounting mechanisms and will begin to discount the recovery before it arrives, it's probably safe to assume that we'll see the markets move higher sometime in 2009.

The X factor right now is employment and of course Friday's report will almost certainly set a negative tone. But remember that unemployment rises, and continues rising after recessions end. Unemployment peaked at 8.6% two months after the end of the 75 recession and peaked at 6.8% 15 months after the 91 recession. The last recession, from Mar '01 to Nov '01 saw unemployment continue to rise to a high of 5.7% for 19 months after the official end.

Gates: I agree the recent market dynamics are primarily caused by a massive de-leveraging process. Hedge funds, firms formerly known as investment banks, and other big institutional investors have been fighting for their lives trying to stay solvent. During this process, fundamentals and valuations have been thrown out the window and spectacular volatility has been thrust onto the market. This makes this market relatively unique from anything we have seen since the 1930s. It is very scary for many investors.

Mr. Barrow could be right that the de-leveraging process may be near its end. In fact, TFS has seen many of our long-short equity and other hedge fund trading strategies normalize a bit recently after months of unprecedented volatility. Of course, though, nobody really knows when the forced selling will stop. For instance, year-end hedge fund liquidations may come in larger than anticipated and may force managers to raise additional cash. But the important thing that investors need to realize is that sooner or later it will pass.

On a positive note, the indiscriminate selling and short covering has produced wonderful opportunities in the markets. Look at the short squeeze that recently occurred in Volkswagen! Owners of that stock had a once in a lifetime opportunity to sell at hugely inflated prices. Also, many closed-end mutual funds owned by retail investors are trading at steep discounts not seen in decades. Investors have the opportunity to buy many of these funds for 70 cents or less on the dollar.

If Mr. Barrow believes that the de-leveraging is about to end, I am surprised that he is not more active in taking advantage of the dislocations that are clearly prevalent in the market. For instance, he could be selling stocks that have been artificially buoyed by short-covering and using the proceeds to buy stocks that have been grossly oversold. These dislocations will go away once the forced trading ends.

Bold: We're not hearing any predictions in our conversations with fund managers. No one we've spoken to is comfortable making any predictions at this point. As prices would indicate, most managers have strong levels of optimism toward future prospects but can't say when things will turn in a positive direction. History tells us the market will advance well in advance of the recession's end, and with Monday's declaration by the NBER that our economy has been in recession since last December, I'm hopeful we're closer to its end than its beginning.

Most managers we're talking to are hopeful that the current projections being made by many economists that the recession will end late in the second quarter next year or sometime mid-year are accurate. Of course, those projections are made with the knowledge that no one knows for certain, and can't possibly take into account any events that are unforeseen. Just [Monday], Bernanke was discussing the impact of the financial crisis on this recession and how it will continue to be intertwined in the recovery as that unfolds.

Gates: In 2009, I think the markets will be less volatile than what we have seen in recent months and that some semblance of rationality will be regained. The reason for this is that I think the highly levered investors have been wiped out already. Plus, the government has had time to put in some backstops to shore up the financial industry.

To capitalize on this belief, we have been gradually increasing our exposure to various trading strategies. In addition, we are actively trading our portfolios to attempt to sell positions that we think our overvalued and to buy positions that we believe are undervalued.

Wiener: Consider that the Dow has seen 27 days this year when the swing from low to high was 5% or more of the prior day's close. Over the past dozen years there were a total of 14 such days. We've had 122 days of 1% moves or greater in the Dow this year. This comes close to the 128 days we saw in 2002, which as you know was the final year of that bear market.

Gates: For undervalued names, I will mention closed-end funds. The median discounts of these securities were 18% as of [Tuesday's] close. In other words, you could spend 82 cents to get something worth $1. Prior to this last summer, we got really excited when the discounts got close to 10%.

For overvalued names, I would look at positions that had large short interest positions over the summer and have outperformed the market since that time. The outperformance could be primarily attributed to short covering.


http://www.forbes.com/intelligentinvesting/2008/12/04/industry-insights-mutual-fund-panelDec5.html

25-11-2008: Deeper downturn in the offing, says Moody Economy.Com

25-11-2008: Deeper downturn in the offing, says Moody Economy.Com
Email us your feedback at fd@bizedge.com

SYDNEY: Although policymakers around Asia insist the region is well-placed to withstand global financial instability, risks of a deeper downturn are rising, said Moody Economy.Com associate economist Alaistair Chan.

He said a number of third quarter (3Q) gross domestic product (GDP) releases highlighted the already-deteriorating situation and Asian countries might face a future of lower potential growth.

“Conditions across Asia continue to worsen. Japan and Singapore are ‘officially’ in recession, and growth in most other countries is slowing. Exports are slowing sharply, and investment is also weak.

“There is a growing realisation that problems in the US are more protracted than first thought and that conditions will not return to the way they were a few years ago any time soon, if ever,” he said in a report yesterday.

Chan said there was a case to be made that a global downturn would hurt Asia more than it would the United States.

“The reason is that Asian countries run current account surpluses, while the US runs a current account deficit. This seems counterintuitive. But it matters because it means Asian countries are mostly net producers, while the US is a net consumer.

“A reduction in global demand means a reduction in global supply, so although the US downturn will trigger this reduced global demand, Asia could bear the brunt of the problem through reduced global supply,” he said.

Chan said much research had been done on the Great Depression and one overlooked reason for why the United States was so affected during the Great Depression was that in the 1930s, the US was the world’s largest exporter and ran the world’s largest current account surplus, while Europe had the place of the US today, running a trade deficit and consuming American goods.

“So when demand collapsed, there was overcapacity, mostly in the United States. Rather than boost domestic demand to absorb the excess production, the government imposed import tariffs, notably the Smoot-Hawley Act. This led other countries to retaliate, further blocking off markets for American goods.

“This resulted in a painful adjustment period, when production had to fall to the level of consumption, which was ultimately corrected with the onset of government spending for World War II,” he said.

Chan said the US now was undergoing another period of adjustment in which consumption and investment relative to GDP fall while saving increased.

Among other things, he said this implied a reduction in the US current account deficit and hence a reduction in Asian current account and trade surpluses. “Given that China is its second biggest import supplier and the country with which it has the largest bilateral trade deficit, it is likely to bear a large part of the adjustment.”

Many commentators claim to know the solution for Asia — stimulate domestic demand. But if the process were straightforward, governments would likely have done so already. The flip side is that they have no other choice. With little demand in Western markets, either domestic demand must compensate, or supply must shrink.

Chan said If the adjustment in consumption and saving in the US was part of a long-term correction, there would be major implications for Asia.

“For one thing, entire export industries will have to be retooled to serve domestic sectors.
“Retooling, say, factories in Shenzhen from assembling iPods and mobile phones toward products that Chinese consumers would buy would require a long process of reconfiguring supply chains across Asia, affecting, among other things, semiconductor production in Taiwan, memory production in Korea and hard drive production in Singapore.”

Chan said the process was likely to take decades. and in terms of government policy, to boost domestic consumption, saving would have to be discouraged.

Is Buffett Insane?

Is Buffett Insane?
By Richard Gibbons November 28, 2008 Comments (38)

In the midst of economic chaos, Warren Buffett recently made a bold prediction. He said that now is the time to buy American stocks.

Of course, this call seems utterly insane. Banks are failing, the credit markets are deadlocked, unemployment is skyrocketing, and there's likely to be terrible news for months.

On the other hand, this is Warren Buffett, and he's made these sorts of predictions before.

1974: Stagflation

The years 1973 and 1974 were two very bad ones for the market. OPEC had started flexing its muscles, causing oil to quadruple. This resulted in a long recession, with inflation spiking to 12.3% in 1974, while real GDP growth fell by 0.5%. America experienced stagflation -- the ugly combination of a recession and high inflation rates -- and people were terrified. The situation was even worse in the United Kingdom, where the government was bailing out banks after real estate crashed. Over those two years, the S&P 500 plunged by 42%.

It was then, on Nov. 1, 1974, at the height of the pessimism, that Buffett made his first well-publicized bullish market call. He noted that he was well aware that the world was in a mess, but that stocks were simply too cheap. "If you're only worried about corporate profits, panic or depression, these things don't bother me at these prices."

To be totally clear, Buffett made one of the most direct predictions of his entire career: "Now is the time to invest and get rich." Buffett himself was buying shares of The Washington Post (NYSE: WPO) and advertising agency Interpublic (NYSE: IPG).

It worked out pretty well for him. The market jumped 32% in 1975, and another 19% the next year. Even today, the Dow Jones Industrial Average's 38% gain in 1975 stands up as its biggest increase since 1955.

1979: An oil crisis

That excellent performance was followed by two poor years. Once again, we were experiencing double-digit inflation and falling GDP growth. Again, we were going through an oil crisis, this one coming in the wake of the Iranian Revolution. As a result, when Buffett made his next call on Aug. 6, 1979, the Dow Jones Average was actually trading lower than it was at the end of 1975.

This time, Buffett noted that stocks were far more attractive than bonds. He believed that pension managers, who were piling into bonds yielding 9.5%, were investing using the rearview mirror. They were avoiding the equities that had recently lost them money. But Buffett recognized that the underlying businesses were actually performing well. A combination of falling stock prices and improving business fundamentals made stocks an attractive investment.

Buffett figured that stocks were probably offering long-term returns of 13% or better. He bought oil producer Hess (NYSE: HES), GEICO, and General Foods, which later became part of Kraft (NYSE: KFT).

This time, Buffett's timing wasn't perfect -- the S&P 500 fell a bit more over the next few months. But his long-term prediction was spot-on. During the 1980s, the S&P 500 rose 13% annually before dividends.

1999: The Internet bubble

In November 1999, during the height of the Internet bubble, Buffett made his only bearish call. At the time, the market was in a speculative fervor, with Internet stocks showing huge price increases seemingly every day. In the five years between 1995 and 1999, the S&P 500 tripled, with compound annual returns of 26%. Many considered Buffett a relic for refusing to buy into the technology boom.

Buffett, however, noted that, because of a combination of cheap initial valuations and falling interest rates, stocks had achieved unprecedented annual returns of 19% over a 17-year period. These results made investors unreasonably optimistic. New investors were expecting 10-year annual returns of 22.6%, while even experienced investors predicted 12.9%. But the huge boom was only supported by modest GDP growth, and therefore wasn't sustainable. So, Buffett expected about 4% real returns.

He continued to hold Coca-Cola (NYSE: KO), Wells Fargo (NYSE: WFC), and M&T Bank (NYSE: MTB), though he noted in the 2004 annual report that he should have sold some of Berkshire Hathaway's overvalued holdings.

Buffett's bearish prediction proved optimistic. The market continued to rise for a few months, with the S&P 500 topping out 9% above where it was when Buffett made the call. But that was followed by a crash. Since his call, the S&P 500 has dropped by 39%, for average annual losses of about 5%, well below Buffett's estimates.

The Foolish bottom line

The common theme of all these predictions is that Buffett didn't care about short-term fears. He wasn't worried about stagflation in the 1970s, and he didn't buy into the unrealistic optimism of the late 1990s. Instead, he rationally valued stocks, and made the right long-term calls. His biggest mistake was the 4% number he threw out in 1999 -- long-term returns have been much worse than his bearish prediction.

But that prediction was too optimistic partly because stocks are so unreasonably cheap right now. And that's why Buffett's buying today.

If you're a short-term speculator, now is a bad time to gamble. But if you're truly in it for the long term, Warren Buffett has made the call. He thinks stocks are cheap. And we agree with him.

Our Motley Fool Inside Value team is astounded at the bargains that we're finding right now. You can read about them by taking a 30-day free test-drive.

Fool contributor Richard Gibbons is terrified, but still thinks this is the time to invest and get rich. Kraft is an Income Investor recommendation. Coca-Cola and Berkshire Hathaway are Inside Value picks. Berkshire Hathaway is also a Stock Advisor selection and Motley Fool holding. The Fool's disclosure policy predicted a McCain victory.

http://www.fool.com/investing/value/2008/11/28/is-buffett-insane.aspx

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