The Currency Market Information Edge

The Currency Market Information Edge
by Investopedia Staff, (Investopedia.com) (Contact Author Biography)


The global foreign exchange (forex) market had an average daily turnover of $3.2 trillion as of April 2007, an increase of 69% from the previous year, according to the 2007 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity, conducted by the Bank for International Settlements. It is by far the largest financial market in the world, and its size and liquidity ensure that new information or news is disseminated within minutes. However, the forex market has some unique characteristics that distinguish it from other markets. These unique features may give some participants an "information edge" in some situations, resulting in new information being absorbed over a longer period. (For background reading, see the Forex Tutorial.)


Unique Characteristics of the Forex Market
Unlike stocks, which trade on a centralized exchange such as the New York Stock Exchange, currency trades are generally settled over the counter (OTC). The OTC nature of the global foreign exchange market means that rather than a single, centralized exchange (as is the case for stocks and commodities), currencies trade in a number of different geographical locations, most of which are linked to each other by state-of-the-art communications technology. OTC trading also means that at any point in time, there are likely to be a number of marginally different price quotations for a particular currency; a stock, on the other hand, only has one price quoted on an exchange at a particular instant. The global forex market is also the only financial market to be open virtually around the clock, except for weekends.

Another key distinguishing feature of the currency markets is the differing levels of price access enjoyed by market participants. This is unlike the stock and commodity markets, where all participants have access to a uniform price. (For more insight, read Basic Concepts Of The Forex Market.)

Market Participants
Currency markets have numerous participants in multiple time zones, ranging from very large banks and financial institutions at one end of the spectrum, to small retail brokers and individuals on the other. Central banks are among the largest and most influential participants in the forex market. However, on a daily basis, large commercial banks are the dominant players in the forex market, on account of their corporate customers and currency trading desks. Large corporations also account for a significant proportion of foreign exchange volume, especially companies that have substantial trade or capital flows. Investment managers and hedge funds are also major participants.

Differing Prices
Banks' currency trading desks trade in the interbank market, which is characterized by large deal size, huge volumes and tight bid/ask spreads. These currency trading desks take foreign exchange positions either to cover commercial demand (for example, if a large customer needs a currency such as the euro to pay for a sizable import), or for speculative purposes. Large commercial customers get prices from these banks that have a markup embedded in them; the markup or margin depends on the size of the customer and the size of the forex transaction.

Retail customers who need foreign currency have to contend with bid/ask spreads that are much wider than those in the interbank market. (For more insight, see The Foreign Exchange Interbank Market.)

Speculative Positions Vs. Commercial Transactions
In the global foreign exchange market, speculative positions outnumber commercial foreign exchange transactions, which arise due to trade or capital flows, by a huge margin, although the exact extent is difficult to quantify. This makes the forex market very sensitive to new information, since an unexpected development will cause speculators to reassess their original trades and cause them to adjust these trades to reflect the new information.

For example, if a company has to remit a payment to a foreign supplier, it has a finite window in which to do so. The company may try to time the purchase of the currency so as to obtain a favorable rate, or it may use a hedging strategy to cover its exchange risk; however, the transaction has to occur by a definite date, regardless of conditions in the foreign exchange market.

On the other hand, a trader with a speculative currency position seeks to maximize his or her trading profit or minimize loss at all times; as such, the trader can choose to retain the position or close it at any point. In the event of new information, the adjustment process for such speculative positions is likely to be almost instantaneous. The proliferation of instant communications technology has caused reaction times to shorten dramatically in all financial markets, not just in the forex market.

However, this "knee jerk" reaction is generally followed by a more gradual adjustment process as market participants digest the new information and analyze it in greater depth.

Information Edge
While there are numerous factors that affect exchange rates, from economic and political variables to supply/demand fundamentals and capital market conditions, the hierarchical structure of the forex market gives the biggest players a slight information edge over the smallest ones.

In some situations, therefore, exchange rates take a little longer to adjust to new information. For example, consider a case where the central bank of a major nation with a widely-traded currency decides to support it in the foreign exchange markets, a process known as "intervention." If this intervention is unexpected and covert, the major banks from which the central banks buy the currency have an information edge over other participants, because they know the identity and the intention of the buyer. Other participants, especially those with short positions in the currency, may be taken by surprise to see the currency suddenly strengthen. While they may or may not cover their short positions right away, the fact that the central bank is now intervening to support the currency may cause these participants to reassess the viability and implications of their short strategy. (For more on interventions, see Profiting From Interventions In Forex Markets.)

Example – Forex Market Reaction to News
All financial markets react strongly to unexpected news or developments, and the foreign exchange market is no exception. Consider a situation in which the U.S. economy is weakening, and there is widespread expectation that the Federal Reserve will reduce the benchmark federal funds rate by 25 basis points (0.25%) at its next meeting. Currency exchange rates will factor in this rate reduction in the period leading up to the expected policy announcement. However, if the Federal Reserve decides at its meeting to leave rates unchanged, the U.S. dollar will in all likelihood react dramatically to this unexpected development. If the Federal Reserve implies in its policy announcement that the U.S. economy's prospects are improving, the U.S. dollar may also strengthen against major currencies. (For a related strategy, see Using Interest Rate Parity To Trade Forex.)

Conclusion
While the massive size and liquidity of the foreign exchange market ensures that new information or news is generally absorbed within minutes, its unique features may result in new information being absorbed over a longer period in some situations.

In addition, the hierarchical structure of the forex market can give the biggest players a slight information edge.

by Investopedia Staff, (Contact Author Biography)
Investopedia.com believes that individuals can excel at managing their financial affairs. As such, we strive to provide free educational content and tools to empower individual investors, including thousands of original and objective articles and tutorials on a wide variety of financial topics.

http://www.investopedia.com/articles/forex/09/forex-information-currency-market.asp?partner=basics2

Stashing Your Cash: Mattress Or Market?

Stashing Your Cash: Mattress Or Market?
by Lisa Smith (Contact Author Biography)


When stock markets become volatile, it makes investors nervous. In many cases, this prompts them to take money out of the market and keep it in cash. Cash can be seen, felt and spent at will and for most people, having money in hand feels safe. But how safe is it really? Read on to find out whether your money is safer in the market or under your mattress.


All Hail Cash?
There are definitely some benefits to holding cash. When the stock market is in free fall, holding cash helps you avoid further losses. Even if the stock market doesn't fall on a particular day, there is always the potential that it could have fallen. This possibility is known as systematic risk, and it can be completely avoided by holding cash.

Cash is also psychologically soothing. During troubled times, you can see and touch cash. Unlike the rapidly dwindling balance in your brokerage account, cash will still be in your pocket or in your bank account in the morning.

However, while moving to cash might feel good mentally and help you avoid short-term stock market volatility, it is unlikely to be a wise move over the long term.

A Loss In Not a Loss ...
When your money is in the stock market and the market is down, you may feel like you've lost money, but you really haven't. At this point, it's a paper loss. A turnaround in the market can put you right back to breakeven and maybe even put a profit in your pocket. If you sell your holdings and move to cash, you lock in your losses. They go from being paper losses to being real losses with no hope of recovery. While paper losses don't feel good, long-term investors accept that the stock market rises and falls. Maintaining your positions when the market is down is the only way that your portfolio will have a chance to benefit when the market rebounds. (For more insight, see How are realized profits different from unrealized, or so-called "paper", profits?)

Inflation: The Cash Killer
While having cash in your hand seems like a great way to stem your losses, cash is no defense against inflation. You think your money is safe when it's in cash, but over time, its value erodes. (Coping With Inflation Risk explains how inflation is less dramatic than a crash, but can be more devastating to your portfolio.)

Opportunity Costs Add Up
Opportunity cost is the cost of an alternative that must be forgone in order to pursue a certain action. Put another way, opportunity cost refers to the benefits you could have received by taking an alternative action. In the case of cash, taking your money out of the stock market requires that you compare the growth of your cash portfolio, which will be negative over the long term as inflation erodes your purchasing power, against the potential gains in the stock market. Historically, the stock market has generally been the better bet.

Time Is Money
When you sell your stocks and put your money in cash, odds are that you will eventually reinvest in the stock market. The question then becomes, when you should make this move. Trying to choose the right times to get in and out of the stock market is referred to as market timing. If you were unable to successfully predict the market's peak and sell, it is highly unlikely that you'll be any better at predicting its bottom and buying in just before it rises. (This strategy is popular, but can few do it successfully, read Market Timing Fails As A Money Maker for tips.)

Common Sense Is King
Common sense may be the best argument against moving to cash, and selling your stocks after the market tanks means that you bought high and are selling low. That would be the exact opposite of a good investing strategy. While your instincts may be telling you to save what you have left, your instincts are in direct opposition with the most basic tenet of investing. The time to sell was back when your investments were in the black - not when you are deep in the red. (To learn more, read To Sell Or Not To Sell.)

Buy and Hold on Tight
You were happy to buy when the price was high because you expected it to go higher. Now that it is low, you expect it fall forever. Look at the markets over time. They have historically gone up. Companies are in business to make money. They have a vested interest in profitability. Investing in equities should be a long-term endeavor, and the long term favors those who stay invested. (My comment: Totally in agreement.) (For additional reading, check out Long-Term Investing: Hot Or Not?)

Nerve Wracking, but Necessary
Serious investors understand that the markets are no place for the faint of heart. Of course, with private pension plans disappearing and the future of Social Security in question, many of us have no other choice. (Be sure to read, The Demise Of The Defined-Benefit Plan, which provides a closer look at this situation.)

Once you've faced the facts, you need to have a plan.

1. Figure out how much money you need to amass to meet your future needs, and develop a plan to help your portfolio get there.
2. Find an asset allocation strategy that meets your needs.
3. Monitor your investments.
4. Rebalance your portfolio to correspond with market conditions, making sure to maintain your desired mix of investments.
5. When you reach your goal, move assets out of equities and into less volatile investments.

While the process can be nerve-wracking, approaching it strategically can help you keep your savings plan on track, despite market volatility.
by Lisa Smith, (Contact Author Biography)

Investing During Uncertainty

Investing During Uncertainty
by Investopedia Staff, (Investopedia.com) (Contact Author Biography)


Every day it seems like the world is getting smaller. If you watch any financial television station or read the newspaper, you are most likely aware of how events in one country seem to have an ever-increasing affect on other countries around the world. We are more interconnected now than at any other time in history. It goes without mention that globalization definitely has its positives, but when threats of financial crisis, war, global recession, trade imbalances, etc, do occur it often leads to talk of moving money to safer investments and increasing government deficits. This rising uncertainty can confuse even the well-informed investor.


Uncertainty
Any time you put money at risk for the chance of profit there is an inherent level of uncertainty. When new threats such as war or recession arise, the level of uncertainty increases significantly as companies can no longer accurately predict their future earnings. As a result, institutional investors will reduce their holdings in stocks considered unsafe and move the funds to other sources like precious metals, government bonds and money-market instruments. This sell-off, which occurs as large portfolios reposition themselves, can cause the stock market to depreciate.

Effects of Uncertainty
Uncertainty is the inability to forecast future events; people can't predict the extent of a possible recession, when it's going to start/end, how much it will cost, or what companies will be able to make it through unscathed. Most companies normally predict sales and production trends for the investing public to follow assuming normal market conditions, but increasing levels of uncertainty can make these numbers significantly inaccurate. (For more, see Recession: What Does It Mean To Investors.)

Uncertainty itself can affect the economy on both the micro and macro level; a description of uncertainty on a micro level focuses on the effect on individual companies within an economy faced with the threat of war or recession, whereas the view of uncertainty on a macro level looks at the economy as a whole (To learn more, see Economics Basics.):

From a company-specific point of view, uncertainty provides a major concern for those that produce consumer goods every day. For example, consumption may fall on the threat of a recession as individuals refrain from purchasing new cars, computers and other non-essentials. This uncertainty may force the companies in certain sectors to layoff some of its employees so that it can combat the impacts of lower sales. The level of uncertainty that surrounds a company's sales also extends into the stock market. Consequently, stock prices of companies that produce non-essential goods sometimes experience a selloff when levels of uncertainty rise. (For more, see The Impact Of Recession On Businesses.)

On a macro level, uncertainty is magnified if the countries at war are major suppliers or consumers of goods. A good example is a country that supplies a large portion of the world's oil. Should this country go to war, uncertainty regarding the level of the world's oil reserves would grow. Because the demand for oil would be high and the supply uncertain, a country unable to produce enough oil within its own borders would be required to ensure that enough oil was stored to cover operations. As a result, the price of oil would increase.

Another macro-level event that affects companies and investors is the flight of capital and devaluation of exchange rates. When a country faces the threat of war or recession, its economy is considered uncertain. Investors attempt to move their currency away from unstable sources to stable ones; the currency of a country under a threat of war is sold and the currencies from countries without the threat are bought. The average investor probably would not do this; however, the large institutional investors and currency futures traders would. These actions translate into a devaluation of exchange rates.

What's an Investor to Do?
When situations of heightened uncertainty arise, the best defense is to be as well informed as possible. Keep updated by reading the newspaper and researching individual companies. Analyze which sectors have more to gain and lose with a war and decide on a long-term plan. Times of heightened uncertainty can lead to great opportunities for investors who position themselves to take advantage of it. Some investors might decide to be offensive and search for companies that provide goods or services that will lead to great returns when things turn around. It is difficult to commit capital during uncertain times, but it can often reap huge rewards in the longer run. Those who want to mitigate uncertainty and risk might be content leaving their money where it is or perhaps moving it to safer securities. Regardless of which strategy you decide to take (if any), you can't go wrong over the long term by keeping yourself well informed and getting into a position so that you can take advantage of prices when the things reverse.

For further reading, see Intro To Fundamental Analysis.
by Investopedia Staff, (Contact Author Biography)Investopedia.com believes that individuals can excel at managing their financial affairs. As such, we strive to provide free educational content and tools to empower individual investors, including thousands of original and objective articles and tutorials on a wide variety of financial topics.

http://www.investopedia.com/articles/basics/03/021403.asp?partner=basics2

Buffett, a Defense of the Oracle of Omaha

Buffett, a Defense of the Oracle of Omaha
David MacDougall
02/12/09 - 10:58 AM EST
It may be too early to count out the Oracle of Omaha.

Some journalists and investors, perhaps suffering from Schadenfreude, have argued that Warren Buffett, chairman and chief executive officer of Berkshire Hathaway(BRK-A Quote - Cramer on BRK-A - Stock Picks), might be nearing the end of his long track record of phenomenal performance.

They point to investments that have fallen more than stock-market benchmarks, as well as a huge derivative book that is sustaining billions of dollars in market-to-market losses during the worst financial crisis in 75 years.

Buffett, who became the world's richest man about a year ago and has since slipped to second place behind Bill Gates, has beaten the U.S. benchmark S&P 500 Index 37 times from 1965 to 2007, according to data published in Berkshire Hathaway's 2007 letter to shareholders. Investors of Berkshire, a holding company weighed heavily toward insurance holdings including GEICO, had an average annual gain of 21.1% during that time, twice as much as the S&P 500's 10.3% advance.

Buffett hasn't fallen into ruts. The few cases of underperformance are aberrations that have quickly reversed course. In 1999, Berkshire trailed the S&P 500 by 20.5 percentage points. A year later, the company's stock beat the benchmark by 15.6 percentage points. The average outperformance following an underperforming year is 19.4 percentage points.

Although Berkshire has large stakes in publicly traded companies, much of its success comes from investments in private firms. Berkshire has private portfolio companies involved in industries such as home furnishing, athletic wear, candy, jewelry and electrical components, to list a few. Those investments follow Buffett's criteria for investing: solid management with a wide "moat," meaning an easily defensible position in the industry.

None of the private portfolio companies is sexy, which is a reason for their success. It is unlikely that any of them will crash and burn because of excessive leverage or an out-of-control derivatives book.

Beyond investments in retailers and public companies, Berkshire's biggest holdings are in the insurance industry. In 2007, Berkshire posted $3.37 billion in pretax profits from underwriting at insurers, which include GEICO, General Re and National Indemnity.

There are no indications from Buffett that any of Berkshire Hathaway's portfolio companies have significant exposure to the toxic assets that have been weakening the competition. This is due to Buffett's ability to identify businesses that are sustainable and worthy of the Berkshire Hathaway seal of approval.

Still, Buffett has made substantial derivative investments, which may be a surprise to some. While "derivative" has become a buzzword that makes many stomachs turn, Buffett's exposure is far tamer than any of the books that have been sinking investment firms throughout 2008.

Seventy-three percent of Berkshire's $9.25 billion derivative book comes in the form of European "put" contracts written by Berkshire Hathaway at the market price for the S&P 500 and three foreign markets with a weighted average remaining life of about 13 1/2 years. Since these are European option contracts, meaning they can only be exercised at expiration, Berkshire Hathaway will only lose money if the index's value at expiration falls below the level it was when the contract was written.

The remainder of the derivative book is in credit default swaps. However, the main hit on the derivative book comes from market-to-market accounting, which forces Berkshire to write down the put contracts to the current fair value, even though Buffett has said he has no plans to sell the contracts before expiration. Those losses will most likely reverse themselves in the coming years as the market rises and credit markets improve.

Buffett has been active in the financial crisis, and injected capital into an ailing bank with more favorable terms than the U.S. government has. In September, he bought $5 billion worth of preferred stock in Goldman Sachs(GS Quote - Cramer on GS - Stock Picks) along with warrants to purchase an additional $5 billion in common stock at a strike price of $115 a share. The preferred stock carries a hefty 10% annual dividend, which will bring in $500 million every year for Berkshire Hathaway, more than the zero percent the government will be yielding on its injected capital.

Criticism of Berkshire's public holdings may be justified with the benefit of hindsight. Some fault Buffett for missing out on a profitable exit from Coca-Cola(KO Quote - Cramer on KO - Stock Picks) at its peak of $86.13 in 1998. Clairvoyance is a lofty expectation even for an oracle.

Buffett has described himself as a long-term investor. Quick exits should not be expected and could even be regarded as a violation of his mandate. Investors ought to realize that Berkshire's portfolio will change little from year to year. Especially for holdings like Coca-Cola, in which Berkshire holds more than 8%, any exit would be very difficult due to the sheer size of the investment.

The composition of Buffett's current publicly traded portfolio, or what was available as of Sept. 30, seems ideal under normal market conditions. It provides for the benefits of diversification with a mix of blue-chip companies in wide-ranging industries.

When the holdings are compared to TheStreet.com Ratings data, a positive picture emerges. While the current universe of rated stocks has only 9% listed as "buy," Buffett's portfolio comprises 19.4% "buy"-rated stocks. All of those shares outperformed the S&P 500 by double digits in 2008.

Stocks in the portfolio with a "hold" rating account for the vast majority. Sixty-seven percent of the Berkshire portfolio has a "hold" rating from TheStreet.com Ratings. A "hold" rating means a stock will probably perform in line with the market. Forty-four percent of stocks rated by TheStreet.com Ratings are "hold." The average outperformance of the "hold"-rated securities of Berkshire Hathaway was 6.4 percentage points in 2008.

Buffett holds some stocks rated "sell" by TheStreet.com Ratings. They comprise 13.8% of the portfolio. Of the stocks rated by TheStreet.com Ratings, 47.25% are rated "sell." In all, Buffett's holdings as of Sept. 30, if equally weighted, beat the S&P 500 by 5.4 percentage points in 2008.

TheStreet.com Ratings' model can be described as "safety first." Neither the model nor Buffett like excessive risk, volatility or debt, and those aversions fare well in a recession.

Buffett Holdings Ranked by
TheStreet.com Ratings

TheStreet.com Ratings



Much of Berkshire's performance is dependent on Buffett's actions after the crash in October. Until the results are available for that time period later this month, we are left to speculate on the possibilities. No investment manager can promise gains, but Buffett is more consistent and honest than most. Just because he isn't ringing up a positive return doesn't mean he has lost his edge.

http://www.thestreet.com/story/10463620/1/buffett-a-defense-of-the-oracle-of-omaha.html

Financial Crisis: Mark to Market Accounting Demystified

Financial Crisis: Mark to Market Accounting Demystified
written by Andy on Wednesday, October 8, 2008

Of late there has been a lot of negative press around the accounting requirements for companies and the methods by which they have to value their assets. Some critics and company executives have even attributed the accounting requirements, and specifically the Mark to Market valuation method, as a major cause behind the rapid failure of some of our largest financial institutions, because they were forced to value assets at unrealistically low levels. The Securities and Exchange Commission (SEC) and Financial Accounting Standards Board (FASB) which sets accounting rules for companies, are being pressured by lawmakers, corporation and big investors to overhaul or suspend the current Mark to Market accounting rules that these companies have to follow. This type of accounting (like leverage), works great in boom times but can place a lot of pressure on companies and their stock prices when asset values fall. As an investor it is important to have a general understanding of how this type of accounting works in order to get a better of the state of the company's real financial health (and so you know what those pundits on CNBC are talking about!). Here, Tony Parker assists in breaking down Mark to Market accounting in an easy to understand format with examples and why it is causing so many headaches for companies.

What is it?

The act of assigning a value to an asset based on it current market value (what it could sell for today) as determined by the going "market price". For example, your house may have been worth $300,000 on 1/1/2007 but today according to the market it is worth $230,000. If you kept track of your assets like a company did, you would be required to "write-down" the value of your house by $70,000 to reflect the fact that if you had to immediately liquidate that asset (your house), it would not bring the kind of cash it would have about two years earlier.

Why was it implemented?

It was primarily intended to prevent shady accounting practices that hide underlying liabilities. The Accounting Standards bodies were concerned that companies were keeping "bad" assets on their books instead of "writing them down" to their real value (assigning a new, lower value to the asset). Mark to Market gives investors a much better "picture" of the health of the company if their assets are correctly priced (i.e. market price).

Example: Ford is holding 100,000 F-150 trucks on a storage lot. Ford originally valued these at $20,000 each. So, Ford books this as an asset with a value of $2,000,000 (100,000 x $20,000). But several months go by and Ford has not sold these trucks (high gas prices, economy, etc.). Now it is 6 months later and Ford must mark to market the value of those trucks for their quarterly reporting. Over the six months the true market value of trucks has dropped to $15,000 (based on what customers are currently paying). In this case, Ford should write-down the total value of the trucks to $1,500,000. This means Ford's assets (the trucks) have fallen in value by $500,000.

So why is this important?

To keep it simple, the most basic thing in accounting is the equation: Assets – Liabilities = Equity or, in common terms, Assets (things owned) minus Liabilities (debt) = Equity (value of the company - reflected in the stock price). If you reduce the value of the assets, then the value of the company must drop, thereby pushing down the equity (stock price). So continuing with the example above, Ford's share price will drop as the value of it's assets (trucks) are marked down. So do you see now how the falls in assets prices can quickly translate to stock prices drops under mark to market accounting?

Why is it causing so much controversy?

The Mark to Market rule works well until you cannot get a realistic price for an asset. Currently, many of the Mortgage Backed Securities (a combination of many mortgages pulled together as one security) that are behind the financial crisis have NO market and hence almost impossible to assign a fair value (unlike those of Ford trucks). Because of their perceived risk and unknown exposure nobody wants them and in many cases if there is no demand they become worthless ($0 value). This obviously is NOT true. Even if the value is 5 cents on the dollar, they still have a value. But the securities are so complex and the economic environment so uncertain, that nobody is willing to "stick their neck out" and try to pick the correct price.

Here is an analogy: Say there is a unique subdivision with 100 gorgeous houses. If these houses were any place "normal" they would be worth $1,000,000 each. But this subdivision sits on top of an old graveyard. Now most people would never pay full price for a house sitting on top of a graveyard (the potential for ghosts and all!). But what is each house worth? Some people probably would not care much about the graveyard as long as they got $200,000 off the selling price. So, is $800,000 the Mark to Market price? On the other hand, some people would only buy one of the homes if it were substantially discounted, say to ¼ of the original price. So, is $250,000 the Mark to Market price?

Now lets add one more obstacle. Let's say – as is currently happening – it is very, very difficult to get a loan (mortgage). There is then the potential that NOBODY would buy one of the homes, because they could not get a mortgage, even though they may have been able to get a big discount. One financial quarter (3 months) goes buy and none of the homes sell. What is the Mark to Market value of these homes now? Without any direct comparisons (after all, this is like no other subdivision), the Mark to Market value would be ZERO. We know that is not true, but if the accountants assign an arbitrary value, say $700,000, they may get in trouble if later they are required to write-down the value of those homes to $250,000 each, when they find out very few people are comfortable living on top of a graveyard. So the problem is: What value should you assign to an asset that has no current market (no buyers)? By the letter of law you value them at current value – zero in this example – but as you can see that is hardly fair.

This is essentially the problem currently choking financial markets with MBS and other housing based instruments. Critics of the Mark to Market accounting rules say that they cause banks to undervalue assets that have a real value based on fire-sale prices in a frozen market.



"A vast majority of mortgages, corporate bonds, and structured debts are still performing. But because the market is frozen, the prices of these assets have fallen below their true value. Firms that are otherwise solvent must price assets to fire-sale values. Not only does this make them ripe for forced liquidation, but it chases away capital and leads to a further decline in asset values," wrote Brian Wesbury in the WSJ.

Conclusion and Opinions

Tony - My personal recommendation is to keep the Market to Mark rule, but in cases where you cannot come up with a reasonable value – because of usual economic forces or a sufficiently liquid market – then guess conservatively and highlight the item to investors in the financial statements, so they can determine whether the value assigned is reasonable to them.


Andy - One point to note is that even if Mark-to-Market rules were suspended, it won't change the makeup of a company's balance sheet. If investors decide certain company's assets are toxic (like MBS nowadays) then it won't matter how a company accounts for them in its books - they will be assigned a zero or negative value by default. To get out of the current financial crisis, investors need to have confidence in the financial assets/instruments of these companies. That is what the government is trying to primarily do with the bailout bill – restore investor confidence by buying and creating a fair market value for these "bad" and illiquid assets. However, judging by recent market action it doesn't look to be working too well.

http://www.savingtoinvest.com/2008/10/financial-crisis-mark-to-market.html

Government thwarts lending, banks claim

Posted on Tue, Feb. 03, 2009

Government thwarts lending, banks claim
Comments (1) Recommend (1)
BY STEVENSON JACOBS
Associated Press

NEW YORK - Banks that are being scolded by the government for not lending are blaming a new obstacle: the government itself.

Fearing more bank failures, federal regulators are forcing institutions to hold more money in reserve and scrutinizing loans. But bank executives complain that the extra oversight thwarts their ability to quickly pump billions of bailout dollars into the ailing economy.

Banks say they are caught in a frustrating Catch-22: How can they make more loans when creditworthy borrowers are scarce, their balance sheets are saddled with bad debt and regulators are hounding them to horde cash?

"We want to lend, but the regulators are flat-out telling us, 'Get your capital up.' Then there's Congress telling you to lend it all out," said Greg Melvin, a board member at FNB, a Hermitage, Pa.-based bank that got $100 million in bailout money.

"Two arms of the government are saying exactly the opposite thing -- it's ridiculous," added Melvin, who is also chief investment officer at investment firm C.S. McKee.

Regulators say they are only being careful, and they deny slowing lending.

"We don't believe that prudence and increased lending are mutually exclusive -- they go hand in hand," said Andrew Gray, a spokesman for the Federal Deposit Insurance Corp.

The tit-for-tat marks the latest problem for the government's financial bailout, known as the Troubled Asset Relief Program, or TARP.

The government rolled out the $700 billion bailout late last year, hoping that injecting money into banks would expand lending and ease the credit crisis. But in a survey released Monday, the Federal Reserve said many banks are making it harder to get credit cards, mortgages and other loans.

Regulators have long required banks to keep a minimum level of capital on their books to stay in business. It was typically a figure equal to 10 percent of assets.

But as the financial crisis has worsened, many banks say they have been told to keep capital equal to at least 12 percent of assets. At the same time, regulators are combing through banks' loan applications and flagging those considered too risky.

It's unclear how broadly the stricter rules are being applied. But interviews with bank executives indicate that healthy and troubled banks are facing more stringent oversight, regardless of whether they have received bailout money.

The goal is to keep banks from getting into more trouble. But to comply, some banks say they have little choice but to scale back lending -- sometimes even to creditworthy borrowers.

Four government regulators oversee the country's roughly 8,500 federally insured banks and thrifts: the FDIC, the Office of Thrift Supervision, the Federal Reserve Board, and the Office of the Comptroller of the Currency.

Regulators shut down 25 banks last year and closed three so far this year because their capital levels fell too low. Meanwhile, regulators have ordered several banks to stop lending until they get more capital.

But the credit crisis has made it harder for banks to raise private capital. And the government doesn't want to give bailout money to banks that might later fail.

The harsh climate has taken a toll on banks such as Los Angeles-based First Federal Bank of California. It was forced to halt lending last month after its regulator, the Office of Thrift Supervision, said it needed more cash to absorb future losses on adjustable-rate mortgages.

Chief executive Babette Heimbuch said her bank wanted to keep lending but had a "difference of opinion" with the OTS over what its cumulative losses were and how quickly it will see them.

"They basically told us to stop lending," she said.

While the Treasury wants banks to lend, "the regulators have a whole different mind-set: They want to protect the insurance funds," Heimbuch said, referring to money that regulators use to insure bank deposits.

Regulators see things differently.

William Ruberry, a spokesman for the OTS, said its No. 1 mission is to safeguard the institutions it oversees. He denied that such efforts were slowing lending.

"We want our institutions to lend, but we want them to lend in a safe and sound way," Ruberry said. "We think creditworthy borrowers shouldn't have a hard time finding loans."

http://www.kansas.com/business/banking/story/686222.html

Credit crunch

Synchronised drowning
By Christopher Hughes

Credit crunch: More than 18 months into the financial crisis, some observers are saying that things just might have stopped getting worse. But even cautious optimism is hard to square with what companies are saying and doing.

True, some recent business surveys – in the US, eurozone, UK and China – showed sentiment rising, albeit from dismal levels. The Baltic Dry Index of shipping rates has doubled although it is still down 90% from its peak last May. Goldman Sachs said its Global Leading Indicator (GLI) suggests “a trough in the global industrial cycle may be in sight”.

But the credit crisis continues to advance with tragic predictability. Ferretti, the Italian yacht maker which epitomised the easy wealth and casual leverage of the credit boom, has skipped an interest payment on its acquisition debt, according to Bloomberg. Hammerson, a UK commercial property developer, announced a rights issue on Monday. And Germany's Schaeffler is battling against a break-up after loading up on debt to gain control of Continental, another heavily indebted German car parts maker.

This is a global crisis. India’s largest discount retailer, Subhiksha Trading Services, suffered widespread vandalism this weekend after running out of cash to pay security staff. The company reportedly admitted to having “mucked up on not raising equity”. In the Far East, suffering is the order of the day. Japanese carmaker Nissan forecasts big losses and Korean electronics producer LG warns revenues, expressed in dollars, will be down 20% this year.

Of course, bad news will keep flowing freely until well after the recession’s trough is crossed. So perhaps the worst is indeed almost upon us. But a more plausible interpretation of the less bad surveys is that the rate of decline has slowed. After the failure of Lehman Brothers last September, credit markets were frozen and modest GDP growth turned suddenly into rapid shrinkage. The shrinkage may now be proceeding at a more moderate pace.

But whether the times are pitch black or only very stormy, there are always opportunities to make money, if only from companies under pressure. Private equity firms specialising in secondary buyouts see rich pickings in the portfolios of capital-constrained banks that are looking to sell what assets they can. And Frank Quattrone, the former Credit Suisse banker who became synonymous with the excesses of the technology boom, is expanding his boutique advisory firm into London. He expects a spurt in tech mergers. As they say, there is always a bubble inflating somewhere.

chris.hughes@breakingviews.com

http://www.breakingviews.com/2009/02/09/credit%20crunch.aspx?sg=telegraph2

Europe's leaders need to wake up to their own recession

Europe's leaders need to wake up to their own recession
French and German leaders have repeatedly called for an overhaul of the global financial system.

By Pierre Briançon, breakingviews.com
Last Updated: 1:09PM GMT 13 Feb 2009

In spite of a poor personal relationship and differences on many other matters, Nicolas Sarkozy and Angela Merkel seem to agree on what the French president calls "the reform of capitalism". Calls for more regulation on banks, hedge funds, rating agencies, short-selling or tax heavens - to name only a few - play well in both Paris and Berlin.

There's a bit of schadenfreude in continental Europe at the crisis of the now much-criticised "Anglo-Saxon" model. That's understandable, after years of being talked down to by the model's practitioners and leading beneficiaries in the City and Wall Street - even though French and German banks tried hard to play with the big boys. But European leaders understandably want to seize the moment to push for greater coordination of global rules, so that tighter regulations in one country won't be undercut by deregulation in another.

Global reforms are certainly desirable, but regulation should not be at the top of the European agenda right now. There are more pressing matters.

The recession is deepening throughout the continent and governments have failed to come up with credible stimulus packages. Germany's GDP is expected to contract by some 2pc this year, France's by more than 1pc. EU members have responded with some sensible ideas, but many are tempted by the dangerous sirens of protectionism and economic nationalism - most recently demonstrated by the French auto industry bailout plan.

This weekend's meeting of finance ministers from the G7 group of industrialised countries in Rome will be the first opportunity for European finance ministers to meet Tim Geithner, their new US colleague. Instead of trying to put regulation on top the agenda, the Europeans should focus on the deepening recession.

Without sensible and coordinated policies to share the economic pain and get the financial system back in operation, the bad times could become much worse. If governments don't rise to the urgent economic and financial challenges, they may find there won't be much left to regulate.

For more agenda-setting financial insight, visit www.breakingviews.com


http://www.telegraph.co.uk/finance/breakingviewscom/4611966/Europes-leaders-need-to-wake-up-to-their-own-recession.html

50 ways to save cash

50 ways to save cash
In hard times, it's more important than ever to ensure that you pay no more than necessary for the essentials of life. Here are 50 ways to get the most from your money.

By Emma Simon
Last Updated: 1:56PM GMT 13 Feb 2009

Hard times make it more important than ever to ensure you do not pay more than necessary for goods and services, while making your savings work as hard as possible for your benefit.

Many hard-working families are feeling the pinch as the economy nosedives, savings rates plummet and cheap credit deals have vanished from the high street. But saving money may be easier than you think. While the weather remains inclement and the children are off school next week, why not take some time to spring-clean your finances?

The Telegraph has compiled 50 ways for families to save money. Work through the list by following the links below and see how much healthier and wealthier your pocket feels (links open in new windows).

Mortgages: Nos 1-7
Credit cards: Nos 8-14
Current accounts: Nos 15-19
Savings: Nos 20-26
Household bills: Nos 27-33
Insurance: Nos 34-41
Pensions and benefits: Nos 42-43
Shopping: Nos 44-48
Investment: Nos 49-50


http://www.telegraph.co.uk/finance/personalfinance/consumertips/4611025/50-ways-to-save-cash.html

Chinalco eventually gets what it wants from Rio Tinto

Chinalco eventually gets what it wants from Rio Tinto
Chinalco is making good on Rio Tinto.

By Una Galani, breakingviews.com
Last Updated: 3:05PM GMT 12 Feb 2009

One year since its audacious dawn raid, the Chinese state-owned aluminium group is set to double its stake in the Anglo-Australian miner. Chinalco overpaid back then, but the holding made sure it was first port of call for a proposed $20bn (£14bn) rescue package for Rio.

In the new deal, the Chinese have agreed to buy US$7.2bn of convertible bonds, at face value, and spend $12.3bn on stakes of up to 50pc in a number of Rio's mining assets. If the bonds are converted into shares, Chinalco would double its total stake in the dual-listed miner to 18pc and get to nominate two directors to Rio's board.

The new investment helps dull the financial pain of buying at close to the peak of the market. Last year it paid $85 a share, based on current exchange rates. It is hard to translate the value of the mine interests into a Rio share price, but people close to the situation suggest the equivalent price for the new proposed investment package is more than $50 a share. That is well above Rio's current $27 share price, but this is meant to be a long-term investment.

Indeed, Chinalco didn't get into Rio merely in search of a financial return. The original investment was widely considered a spoiler for rival BHP Billiton's proposed merger with Rio. The Chinese authorities were openly hostile to a deal that would have created a much more powerful supplier of iron ore and other key commodities. The move by state-owned Chinalco probably helped scupper the plan.

China may be suffering now, but it will always be hungry for commodities. There is no better way to keep prices down than to keep supply ample. Chinalco's latest deal will put the country in a position to do exactly that. Providing the transaction doesn't get blocked by Rio's frustrated shareholders or the Australian foreign investment board, Chinalco will have extracted what it really wanted.

For more agenda-setting financial insight, visit www.breakingviews.com

http://www.telegraph.co.uk/finance/newsbysector/energy/4601828/Chinalco-eventually-gets-what-it-wants-from-Rio-Tinto.html

Opportunity Knocks: Has the oil price bottomed?

Opportunity Knocks: Has the oil price bottomed?
Few areas have escaped the stock market down turn – some have performed worst than others. The price of oil has fallen from a peak of $147 to around the $40 mark which could be throwing up a buying opportunity.

By Paul Farrow
Last Updated: 9:44AM GMT 13 Feb 2009

The oil price has fallen from a peak of $147 to around $44 a barrel Photo: BLOOMBERG NEWS
The financial crisis has left many assets and sectors battered and bruised. The stock market is down by more than 30pc over the past year. The global economy is on its knees but history suggests that equity markets will begin their recovery before GDP figures start to show strength again.

Investors who will gain the most will be those with either the nous or the brass neck to get in early. There are some fund managers that reckon that the fall in the oil price could open such an opportunity. The question is whether those investing in the sector now are jumping the gun?

Oil reached a peak of just under $150 a barrel last year – today it stands at jaround $40. The demand that pushed the price to record highs has slumped as many global economies have slowed. Some analysts are reticent to suggest how long the global recession will last, but when the stimulus injected by central banks begins to filter through the demand for oil will pick up.

Several already believe that investors should start to look at oil – they do not say the price has bottomed or a spike in the price is imminent, but they reckon that a floor cannot be too far away.

Demand for oil has collapsed because of the very weak economic conditions, and the price of oil has fallen as a result. Production is also falling – non-OPEC production peaked last year and is now on the decline.

This week, crude fell after the US Energy Information Administration revised down its 2009 global oil demand forecast by 400,000 barrels per day from its previous outlook, predicting demand will fall by 1.17 million bpd this year from 2008 levels. US crude stands at around $34 a barrel. London Brent stands at $45 a barrel.

But Killik, the stockbrokers sent a note to investors reckoning the "momentum is negative and crude is approaching oversold levels – short-term traders should go long at current levels with a tight stop loss'.

Mick Gilligan, an analyst at Killik says the price of oil is wrong in the medium term and says that his clients are buying exchange traded funds to benefit from the low price – particularly US oil which is lower than the price of Brent crude.

Chris Wheaton, Director, RCM, the specialist equity company of Allianz Global Investors, says: "Oil has been included in the January sales. Even if oil is only $50/barrel in 2010 it makes for a great investment opportunity right now. Low prices are encouraging more energy use – for example, gasoline demand in the US is now at the same level it was last year despite all the talk of a weak US economy. Sometime in 2009 or early 2010 we expect oil demand across the world to start to grow again.

"The credit crunch and uncertainty over oil prices are causing investment in new oil fields to be put on hold. However the big trends, such as rising energy use across emerging markets and natural declines in existing oil production won't disappear and will continue to push oil prices higher. This means were certainly going to have $100/barrel oil again by 2013, and makes longer-term investments in energy at today's prices look very attractive."

Robin Batchelor manager of the Blackrock World Energy fund says that both oil and gas prices are trading below their marginal costs, which are unsustainable for any reasonable time frame – but he admits that economic woes do raise concerns on the demand side of the equation.

He says:"However, energy equities are trading at P/E multiples at a discount to the broader market and are generally supported by asset valuations. Almost all the companies in the portfolio are well-capitalised and generating cash. At some point in the relatively near future, we believe fundamental factors will regain their importance as investors again return to traditional valuation techniques."

Gary Dugan, Chief Investment Officer, EMEA, Merrill Lynch GWM, reckons that for those who want to trade oil, we are very close to buying levels – anything below $35 is a buying opportunity.

He says: "When the oil price starts to move towards $30 a barrel it starts to cost more to extract oil than producers can get by selling it, so production facilities get shut down as they become uncommercial. We expect the annual production of oil to fall by as much as 5pc a year over the next five years, which should create a floor for the oil price. We believe that oil will bottom out at around $30, and will average between $40 and $45 over the course of 2009, subsequently rising to around $55-60."

But before investors rush to get a piece of the action, there are some who are not so sure now is the time.

Ian Henderson, who manages the JPMorgan Natural Resources Fund, is not convinced that now is the ideal time to invest in oil related plays – mainly due to the uncertainty of the US, which he says will dictate sentiment. He continues to bet on gold which makes up the lionshare of his portfolio at this juncture.

"The long-term view remains in tact but there is so much global uncertainty. But there are dozens of cargo ships floating around refineries because demand for oil is weak -there is plenty of oil floating around – it could be that we will have to wait until that is through the system before the price rises," he says. "However, many oil companies have strong balance sheets having been buoyed by the high price in the past which makes some oil stocks a useful hold for those looking for dividends – although so too do the likes of Vodafone and Glaxo."

For investors wanting to take advantage of any future rises in the price of oil, there are a number of choices. You could invest directly in the shares of the oil majors and production and service companies. Other options include investing in funds that look at the oil sector (Guinness Global Energy, JPM Natural Resources, Investec Energy), or in an exchange-traded fund, which is an investment vehicle that holds assets such as stocks or bonds.

Oil shares do not move directly in line with the oil price because there are other factors at work such as management skill, debt and the costs of distribution. However, there is a correlation over the longer term and they are paying decent dividends.

Remember that oil stocks in the UK make up a significant chunk of the FTSE100 so any tracker fund or General UK Growth fund that does not veer too much away from the index will benefit from any pick up in demand for oil – and those bumper dividend payments.

http://www.telegraph.co.uk/finance/personalfinance/investing/4609834/Opportunity-Knocks-Has-the-oil-price-bottomed.html

Pros and cons of corporate bonds.

'Fixed interest of 6.4pc for the next 10 years. What's the catch?'
This week's Diary of a Private Investor looks at the pros and cons of corporate bonds.

By James Bartholomew
Last Updated: 12:17PM GMT 12 Feb 2009

There has been much talk about how savers cannot get a decent rate of interest on money any more. But there is one place where savers can get pretty good rates: corporate bonds. A fixed return of 5pc a year is easily available with little risk. Rates of up to 8pc can be had for those willing to face more danger.

I have bought into corporate bonds for two reasons. One is to get the good yields. The other is because I read recently that a rise in corporate bond prices has preceded all, or at least most, bull markets in shares for many decades. So I hope that the corporate bond market will give me a prompt when it is time to go full-bloodedly back into shares.

What are corporate bonds? They are debt issued by companies in the form of tradable securities. For example, I hold some bonds that were issued by British American Tobacco (or a subsidiary, BAT International Finance, to be precise).

These bonds are due to be repaid in 2019. The "coupon" or rate of interest for a nominal £100 of stock is 6.375pc. But the bonds are quoted at the moment at a fraction below that nominal value, which means the yield is a tiny bit higher. So there it is: fixed interest of about 6.4pc for the next 10 years. What is the catch?

Well, there are a few problems but none that has deterred me. One difficulty is that the market in corporate bonds is a lot less liquid than in shares. It is not always easy to get stock at a price close to the supposed middle price shown by various sources.

The free source I have been using is www.fixedincomeinvestor.co.uk, where you can find a long table of bonds if you go to "bond prices and yields" and then "GBP bonds (Corporate and Non-Gilt)". When I bought the BAT bonds I certainly had to pay 3pc or 4pc above the price quoted. The same happened when I bought some British Telecommunications PLC 8.625pc bonds repayable in March 2020.

But the biggest discrepancy came when I was attracted by the bonds issued by Enterprise Inns with a coupon of 6.5pc but quoted at a mere £40 for £100 nominal of stock. The bond is repayable in full in 2018 so the yield to redemption – which includes the capital gain – looked like a whopping 21.7pc.

But when I got on to my broker to see if I could buy some, I was told the best actual offer was at £66. The price on the screen proved to be pretty theoretical so I held off. Then I read an article that suggested Enterprise Inns might be in danger of breaching the covenants attached to its bonds.

I rang Enterprise Inns hoping that, as an owner of shares in the company, a prospective owner of its bonds and a financial journalist, it might explain more about its covenants. Without going into detail, my attempts to glean information from its investor relations officer (off sick) and its press office proved less than wholly successful.

I was instructed via an outside press relations company to send questions by email. A bad sign. Finally I managed to have a useful conversation with this press company. But the reluctance by Enterprise Inns to communicate left me thinking "why don't they want to talk?"

How safe are corporate bonds? It depends on the company. Safer than Enterprise Inns bonds are those issued by Tesco. They are repayable in 2019 and have a coupon of 5.5pc. They are quoted as I write at 102.4 so the redemption yield is 5.1pc. That is not big enough to tempt me but for those who are desperate for safe income, it is.

Unlike many bonds, this one can also be bought in small amounts – the minimum is apparently £1,000 of nominal stock. Another bond that can be bought on a small scale is issued by Compass Group.

For people who don't want to invest directly, investment management companies can sell you a fund invested in a spread of corporate bonds.

Corporate bonds are a kind of halfway house. They are not as safe as government bonds but they are safer than shares, ranking above them if a company goes bust. The encouraging thing, as far as shares are concerned, is that since November corporate bond prices have been rising.


http://www.telegraph.co.uk/finance/personalfinance/investing/4600899/Fixed-interest-of-6.4pc-for-the-next-10-years.-Whats-the-catch.html

Your Best Chance to Profit in 2009

Your Best Chance to Profit in 2009
By Richard Gibbons February 12, 2009 Comments (0)

If, after 2008, you're still looking at the stock market as a way to fund your retirement, most people probably consider you a few congressmen short of a bailout. (Zing!) It's probably progressed far beyond the point of people refusing to make eye contact with you. In all likelihood, your dog is, too.

Yes, it's tough proclaiming yourself a bull after a year in which every bull became a steer.
But there are a few perks. Like getting the profits that come from buying stocks at what could be some of the best prices you'll ever see.

A brief history of 2008
Last year was a fantastic demonstration of what happens when, in a highly leveraged world, everyone needs liquidity at the same time.

Anyone who borrowed to buy mortgage-backed securities needed cash as mortgage values plummeted. Investment banks like Bank of America (NYSE: BAC) prey Bear Stearns needed cash as the mortgage-backed securities on their books began to fall. Retail banks like Wells Fargo's (NYSE: WFC) Wachovia needed cash to maintain their capital ratios as defaults escalated. AIG needed cash to balance its losses in credit default swaps. Hedge funds needed cash to fund redemptions and reduce leverage as assets declined.

The problem is, when everyone needs cash, the only way to get it is to sell off assets. And that's what investors did, dumping almost every asset class with the exception of ultra-safe Treasuries. The stock market took it on the chin.

An overreaction
That's not to say that the market collapsed simply because everyone cashed out. The problems in our economy are real. We've seen huge bankruptcies, the unemployment rate has spiked beyond 7%, and consumer confidence is low. Companies that need cash are finding it tough raising money at reasonable costs.

But the carnage in the market isn't limited to the shaky companies that are likely to suffer the most. The S&P 500 contains the biggest, most successful, and most stable businesses in America. Yet more than 94% of the companies in the S&P 500 fell during 2008. Over 30% lost more than half their value! Certainly, deteriorating business prospects are responsible for some of that drop. But based on valuations, it seems likely that stock investors are selling because they must. Like everyone else, they need the cash.

And that's a really great thing if you're not one of Wall Street's forced sellers.

The sweet spot
Large-cap value stocks could be the best way to exploit this opportunity. I'm not just talking about slow-growing companies trading at low single-digit earnings multiples, but also compellingly cheap growth stocks.

For instance, these days, the universe of large-cap value stocks includes Apple (Nasdaq: AAPL). Apple has huge barriers to competition, $25 billion of cash on its balance sheet, an innovative culture, a 19% estimated annual growth rate going forward, and is trading for about 9 times free cash flow. At these prices, Apple is a large-cap value stock.

So why are large-cap value stocks a great investment these days?
Not because these stocks are certain to outperform the other categories under all circumstances, but because they present the ideal trade-off between risk and reward in these troubling times.

While there's a good chance that the economy will start showing signs of life sometime in 2009, there's a possibility that things will get even worse. When you're betting your retirement, you should own businesses that can survive the worst-case scenario.

Low risk, high reward
Generally, large-cap stocks fit that criterion. They have the most stable cash flows, the most well known brands, the greatest economies of scale, and the best chance of recovering from mistakes.

Would you put your money on Coca-Cola (NYSE: KO) to withstand a depression, or Jones Soda (Nasdaq: JSDA)? Would you bet on CVS (NYSE: CVS), or Rite-Aid (NYSE: RAD)? These two examples may be somewhat hyperbolic, but it's absolutely true that powerhouses like Coke and CVS are far more likely to survive than companies with smaller moats because they have the financial clout, the economies of scale, and the proven, winning business models.

In normal times, you'd really have to pay up for these sorts of dominant companies. But thanks to forced selling from investors struggling to raise cash, right now you can buy some excellent businesses extremely cheaply.

The S&P 500 is trading at just over 12 times 2009 earnings estimates, its lowest earnings multiple since the 1980s. What's more, due to the poor economy, the earnings of these powerhouse companies will be depressed in 2009, which means that the normalized earnings multiple is even more compelling. Large-cap stocks are extremely cheap, and I believe will offer superior returns over the next few years.

The Foolish bottom line
Of course, you still have to be careful -- as 2008 has shown us, you can't just throw a dart at the S&P 500 and expect to avoid a blow-up. You still need to pay attention to balance sheets and how much cash companies are bringing in during these troubling times.

But if you're alert, you can find the stocks right now that will pay for your retirement. So, now is a good time to start buying large-cap value stocks.

This article was originally published on January 8, 2009. It has been updated.

Fool contributor Richard Gibbons knows all too well the pain of becoming a steer. He doesn't own shares of any companies mentioned in this article. Apple is a Motley Fool Stock Advisor recommendation. Coca-Cola is an Inside Value pick. Bank of America is a former Income Investor choice. The Fool's disclosure policy wears a large cap to avoid sunburn.

http://www.fool.com/investing/value/2009/02/12/your-best-chance-to-profit-in-2009.aspx?source=iflfollnk0000001

Investments for a Recession

Investments for a Recession
By Selena Maranjian February 12, 2009 Comments (2)


Are you ready for a prolonged recession, a downturn in the stock market and economy? What can you do to prepare for it? Well, a bunch of things. One strategy that has received a lot of attention lately is investment in exchange-traded funds (ETFs), which focus on stocks outside the U.S. and on "defensive," or recession-resistant, industries.

Global ETFs
There are a variety of ETFs that invest globally. For instance, the Vanguard All World ex-US (VEU) ETF has half of its assets in Europe and another third in Asia. Of course, foreign companies and economies are still affected by what happens in the U.S., so you won't completely avoid the effects of the current recession. But with more than 2,000 holdings, including Nokia (NYSE: NOK), Toyota Motors (NYSE: TM), and BP (NYSE: BP), you'll at least get plenty of diversification.

One area many people think of as a defensive industry is the consumer-staples sector. Many companies in the sector, such as Procter & Gamble (NYSE: PG), Altria (NYSE: MO), and Coca-Cola (NYSE: KO), are often thought to be as close to recession-proof as you can get. Still, don't expect miracles. Inflation and the rising cost of raw materials can put pressure on these companies' profits, too.

Looking for income
Dividend stocks are another place to turn when you have recession on your mind. The iShares Dow Jones Select Dividend Index (DVY) ETF can help you out. It offers bits of about 100 dividend payers, such as Merck (NYSE: MRK), for the price of one. Many of these companies tend to be in defensive industries, such as the aforementioned consumer staples, pharmaceuticals, and utilities, although some are also in the recently beleaguered financial sector. This ETF's yield is almost 7%.

Putting some bonds in your portfolio can add a healthy dose of diversification, too. Some municipal bonds currently yield more than comparable Treasury bonds do, even though they pay tax-free income. But remember that in the long run, stocks have usually trounced bonds, so don't go nutty with them unless you're in or nearing retirement. And be especially careful of esoteric securities like emerging-market debt, because the risks can be extremely high.

Keep in mind
Of course, safety in a recession involves more than just having the right investment mix (and I wouldn't even argue with those who advise not changing your mix at all, but just sticking with your convictions and waiting out the recession). For example, you should also:
Have an emergency fund in which you aim to keep between three and six months' worth of living expenses in short-term investments. These can be critical if you suddenly lose your job (hey, it happens, and more often in a recession) or encounter other unexpected big-ticket expenses (an operation or a new roof). Get more guidance in our savings area.

Develop a healthy perspective on recessions.
Welcome them, because they tend to bring bargains in the stock market. While others panic and sell, review your watch list regularly with a box of tissues nearby to help contain your drooling.

Learn more in these articles:
An Opportunity We Haven't Seen in 50 Years
The Best Stock to Own
The 10 Best Dividend Stocks of the Past Decade

http://www.fool.com/investing/dividends-income/2009/02/12/investments-for-a-recession.aspx

Wall Street IB: 12 months losses exceeded last 25 years profits

Speaking at the World Economic Forum in Davos, Switzerland a few weeks ago, Russian Prime Minister Vladimir Putin declared he would break from the recent pastime of blaming America for the world's economic struggles.

"Virtually every speech on this subject [has] started with criticism of the United States. But I will do nothing of the kind. … I just want to remind you that, just a year ago, American delegates speaking from this rostrum emphasized the U.S. economy's fundamental stability and its cloudless prospects. Today, investment banks, the pride of Wall Street, have virtually ceased to exist. In just 12 months, they have posted losses exceeding the profits they made in the last 25 years."

http://www.fool.com/investing/international/2009/02/12/why-russia-is-collapsing.aspx?source=iedsitmrc0000001

Permanent loss of capital vs. stock price drop

7 Stocks That Could Cause Permanent Losses
By Alex Dumortier, CFA
February 12, 2009 Comments (1)

In a recent research note to clients, Societe Generale investment strategist James Montier identified 42 stocks worldwide that he believes threaten investors with a permanent loss of capital.

So what?
Montier is not your run-of-the mill investment strategist, which is one of the reasons I follow him. For instance, he once published a research note on the psychology of happiness with 10 suggestions, including the following: "Have sex (preferably with someone you love)."

Don't be fooled by this unorthodox style, though. Montier is no charlatan -- he's an expert on behavioral finance, and his work is steeped in the no-nonsense principles of value investing, as laid out by legendary teacher-investor Ben Graham.

In other words, it's worth your time and money to listen to what he has to say -- particularly on a matter as serious as preserving your assets.

Permanent loss of capital vs. stock price drop
First, let me emphasize what value investors refer to by a permanent loss of capital. Whether stock losses are permanent can be determined only if you have a notion of the stock's intrinsic value. Two sets of circumstances can result in permanent loss:

1. Either your cost basis was materially higher than the intrinsic value, or
2. the intrinsic value itself has declined.
   

It's vital to understand that a drop in stock price does not cause a permanent loss of capital. Rather, if there is a mismatch between price and intrinsic value, there will be a downward adjustment in the stock price -- don't confuse cause and effect. Furthermore, not all stock-price drops are the product of latent permanent losses -- they may have other causes, such as forced selling and investor irrationality.

The trinity of risks
Now that we know what it is we are trying to avoid, let's focus on the three factors Montier refers to as the "trinity of risks" that can produce such losses:

1. Valuation risk: If earnings are at a cyclical high, the current P/E may be masking an overvalued stock. Montier uses an adjusted P/E ratio that replaces current earnings per share (EPS) in the denominator with a 10-year average EPS. This approach smooths out the effect of earnings volatility and comes straight from the Ben Graham playbook. When screening for danger, Montier looks for stocks that have an adjusted P/E ratio of greater than 16.

2. Balance sheet / financial risk: Excessive leverage can put a company into bankruptcy, no matter how sound the underlying business. Investors need to be particularly sensitive to financial risk in an environment that combines a contracting economy and tight credit.

The Z-Score is a statistical indicator of bankruptcy risk developed by Edward Altman of NYU. Montier's screen identifies companies with a Z-score below 1.8, the "distressed" range in which companies run a significant risk of bankruptcy.

3. Business / earnings risk: If current earnings are significantly higher than their recent historical average, investors may extrapolate future earnings from an inflated base and award the stock a valuation it doesn't deserve. This risk is exacerbated at the tail of a bubble. Montier looks for companies with current earnings per share that are double or more the 10-year average.

Using Montier's three criteria, I ran a screen and came up with 19 mid- and large-cap U.S. stocks. The following table contains seven of them:

Stock
Adjusted Price/ Earnings Ratio*
Z-Score
Current EPS/ 10-year Average EPS*

Wynn Resorts (Nasdaq: WYNN)
73.3
1.32
5.8

CME Group (Nasdaq: CME)
29.9
0.69
2.6

XTO Energy (NYSE: XTO)
26.4
1.44
2.6

Transocean (NYSE: RIG)
26.2
1.74
6.9

Williams (NYSE: WMB)
24.0
1.20
2.5

NYSE Euronext (NYSE: NYX)
18.5
1.39
2.6

Norfolk Southern
17.5
1.79
2.11


*Note that, in certain cases, the average earnings were calculated over fewer than 10 years for lack of data. Source: Capital IQ, a division of Standard & Poor's, as of Feb. 3, 2009.


A couple of surprise guests
I was surprised to find exchange operators CME Group and NYSE Euronext on the list, as theirs is a sector I find attractive right now. Perhaps this illustrates one of the limitations of mechanically screening by adjusted P/E and comparing current earnings to the 10-year average: It doesn't allow you to distinguish between secular increases (or declines) in earnings and cyclicality. Both companies became publicly traded within the past 10 years, so their focus on profit growth is boosted.

Here's an extreme example: Google's (Nasdaq: GOOG) earnings per share have, on average, doubled every year over the past five years; in this instance, it's pretty clear that using the 10-year average EPS to calculate the P/E would actually muddy the waters. An average earnings figure calculated over a period of strong growth is inadequate to describe the company's true earnings power at the end of the period.

Safety first
All the same, the results should give investors pause -- the other companies in the table are clearly cyclical, particularly those in the energy sector (Transocean, XTO Energy, and Williams). Cyclical or not, if you own any of the stocks in the table, it may be worth revisiting your analysis in light of these results.

James Montier's methodology is an excellent illustration of the way value investors think about avoiding permanent losses. The team at Motley Fool Inside Value follows the same principles to help their members sidestep sinkholes and invest in well-run, well-capitalized businesses trading at cheap prices.

Fool contributor Alex Dumortier, CFA, has no beneficial interest in any of the companies mentioned in this article. Google and NYSE Euronext are Motley Fool Rule Breakers picks. The Motley Fool has a disclosure policy.

http://www.fool.com/investing/value/2009/02/12/7-stocks-that-could-cause-permanent-losses.aspx