1 Qtr Numbers

Stocks ended up for the day but down on the quarter, with the Dow down 7.55%, the S&P 500 down 9.92% and the Nasdaq down 14.07%. This was the worst quarterly performance since the 3rd quarter of 2002. The indexes did bounce off of their lows for the quarter, being down between 12% and 18%.

The question is the market trying to find the bottom, or is this a pause before it drops further? My guess is that as long as there are no new big blow ups the market will trade around this level until next year.

Not to say that Wall Street was overly optimistic, but the down markets seemed to be a surprise.

One reason for the uneasiness (or rotten quarter) is that many on Wall Street expected the first quarter to be much stronger for stocks than it turned out to be. The theory was that big financial firms had taken their hits in the final three months of 2007. However, as the first quarter has shown, the fallout from investments in risky and possibly worthless mortgage-backed securities has continued along with the uncertainty in the credit markets

Source:
'Stocks Gain on Last Day of Quarter', By Tim Paradis, AP Business

Be A Lazy Investor - Part Two

Earlier I posted about how hard work can actually hurt you as an investor. Most people, those not involved in financial markets, do not have the time, tools, skills or the experience to be really good at picking stocks or mutual funds that consistently beat the market. Even if you do invest in the market, you probably do not make as much as you think due to fees, expenses and taxes.

The Pros Can't Beat Market All The Time

Professional mutual fund managers are not able to consistently beat the market. Here is an excerpt from a Motley Fool on line article on mutual funds,

Though you would think that mutual funds provide benefits to shareholders by hiring alleged "expert" stock pickers, the sad truth of the matter is that the vast majority of mutual funds underperform the average return of the stock market. Over time, because of their costs, approximately 80% of mutual funds will underperform the stock market's returns.

In an article in the FPA Journal, Thomas McGuigan studied the returns of large-cap and mid-cap mutual funds over a period of twenty years. Their conclusion was that very few could consistently beat the market over long time periods. Their study also showed that it was impossible to predict which funds would outperform their index. I guess that is why every investment advertisement says that "...Past performance is not a guarantee for future returns."

Below are tables comparing large-cap and mid-cap with an index fund. The large-cap funds were compared to the Vanguard 500 Index Fund. For mid-caps, there was no mid-cap index fund present over the entire study period, so a proxy index fund was created for the study.

The data in the table reflect four main findings:

• The longer the investment time frame, the more difficult it was for active managers to outperform the index fund.
• The percentage of funds that outperformed the index fund over a 20-year period was 10.59 percent.
• The distinction between returns based on growth, value, and blend styles faded as the investment time frame lengthened.
• A long-term investor (10-20 years) had a 10.59 percent to 24.71 percent chance of selecting an actively managed fund that outperformed the index fund.

The data in the table reflect four main findings:

• The longer the investment time frame, the more difficult it was for active managers to compete with the index fund.
• The percentage of funds that outperformed the index fund over both 15- and 20-year periods was 2.63 percent.
• The distinction between returns based on growth, value, and blend styles faded as the investment time frame lengthened.
• A long-term investor (10–20 years) had a 2.63 percent to 13.16 percent chance of selecting an actively managed fund that outperformed the index fund.

How To Beat The Pros

Be lazy, don't invest in individual stocks or actively managed funds. Don't pay attention to Wall Street, CNBC or any Get-Rick-Quick investment schemes.

All you need is a portfolio of just three index funds and you could have beat the S&P 500 last year along with beating it over the past three and five year periods. Below is a chart comparing three portfolios: Second Grader's Starter, S&P 500 and T Rowe Price's 2040 Retirement Mutual Fund. I wanted to throw a retirement/lifestyle fund into the mix to provide a better compassion to the Second Grader's Starter portfolio.

	Portfolio	Equity %	1 Year Return (3)	3 Year Annualized Return (3)	5 Year Annualized Return (3)
	Second Grader's Starter (1)	90%	8.83%	12.31%	17.02%
	S&P 500 (1)	100%	5.49%	8.62%	12.83%
	T Rowe Price 2040 Fund (2)	91%	6.67%	10.31%	14.76%

1) Source: Morningstar Inc
2) Source: T Rowe Price
3) Returns as of 01/03/2008

The Second Grader's Starter was developed by Allan Roth, a Colorado Springs CPA, for his 7-year old son in 2004. Allan developed a portfolio of just three Vanguard mutual funds, Total Stock Market Index, Total International Stock Index and the Total Bond Market Index. This portfolio has four huge advantages for it:

• Owns the entire world and has maximum global diversification;
• Has less than 0.25 percent annual expenses, both hidden and disclosed;
• Is extremely tax-efficient, and
• Automatically re-balances within U.S. and international markets.

The suggested portfolio breaks out as follows, depending on your risk tolerance.

	Investment	High Risk (1)	Medium Risk	Low Risk
	Vanguard Total Stock Market Index VTSMX	60%	40%	20%
	Vanguard Total Intl Stock Index VGTSX	30%	20%	10%
	Vanguard Total Bond Market Index VBMFX	10%	40%	70%
	Totals	100%	100%	100%

1) This was the fund allocation used in the Second Grader's Starter Portfolio noted above.

Other Lazy Portfolios

In 2004, Paul B Farrell published 'The Lazy Person's Guide to Investing: A Book for Procrastinators, the Financially Challenged, and Everyone Who Worries About Dealing With Their Money', which showed the benefits of a simple, easy to maintain and understand portfolio of mutual index funds. Currently he writes for Marketwatch.com and has been tracking several 'Lazy Portfolios':

Equity Returns for 8 Lazy Portfolios:

	Portfolio	Equity %	# of Funds	1 Year Return (1)	3 Year Annualized Return (1)	5 Year Annualized Return (1)
	Aronson Family Taxable	80%	11	13.54%	16.23%	21.47%
	FundAdvice Ultimate Buy & Hold	60	11	6.93%	14.44%	20.32%
	Margaritaville	67	3	10.51%	14.01%	18.63%
	Yale U's Unconventional	70	6	2.78%	12.08%	18.12%
	Dr. Bernstein's Smart Money	60	9	3.72%	11.43%	17.75%
	Dr. Bernstein's No-Brainer	75	4	6.79%	11.59%	17.47%
	Second Grader's Starter	90	3	8.83%	12.31%	17.02%
	Coffeehouse	60	7	-0.23%	9.75%	16.71%
	S&P 500	100	n/a	5.49%	8.62%	12.83%

1) Returns as of 01/03/2008

The portfolios vary in complexity, both in number of funds and in amount of maintenance required, and in returns. One of the main points that gets repeated over an over is to take the emotion out of your investment decisions and re-balance. The article quotes Ted Aronson, AJO Partners' founder and developer of the Aronson Family Taxable portfolio,

Now comes this year's big lesson: Aronson warns that most investors will psychologically resist selling the big winners and buying lesser performers. But that's what re-balancing and "Modern Portfolio Theory" (the theory behind Lazy Portfolios) is all about. You stick to your asset allocations as sector performance waxes and wanes over the long-term. Otherwise you're just chasing hot sectors and engaged in high-risk market-timing

Really Really Lazy Portfolios

For some people, having to invest in three funds and then re-balance every year is still too much work. Not to worry, mutual fund companies have developed Life Style or Target Retirement funds. These funds are a one-stop-funds that invest in a basket of stock and bond mutual funds, shifting overtime from more stocks in the early years to more bonds as the 'target' age is reached. These funds will even re-balance as needed to maintain their asset allocations, all you would need to do is fund the investment.

With this type of investment it is very important to pick a mutual fund company (Fidelity, T Rowe Price or Vanguard) that has low management fees. A minor point to look into is the asset allocation of the funds as there are some differences which may affect returns. See table below for a comparison

	Investment	% of Stock	% of Bonds/Cash	Foreign Stocks as a % of Stocks
	American Century LIVESTRONG 2035 ARYIX	74.9%	25.1%	15.8%
	T. Rowe Price Retirement 2035 TRRJX	87.5%	12.7%	22.4%

1) Source: Morningstar Inc

It Seems So Easy?

It is that easy. Granted there will be people who will say that these portfolios will not work, or that they can't be any good cause they are too simple. The evidence shows that these methods do work, are easy and can be very profitable. As Paul Farrell noted: "Nothing saved ... equals nothing invested ... equals nothing compounded ... equals a less than dreamy retirement".

Source:
"The Difficulty of Selecting Superior Mutual Fund Performance", Thomas P. McGuigan, CFP, FPA Journal
"Lazy Portfolios Annual Update For Recssion '08", Paul B. Farrell, Marketwatch.com
"How An 8-year Old Crafted A Simple Winning 'Lazy' Portfolio", Paul B. Farrell, Marketwatch.com
"2nd-Grader's Portfolio Takes On Wall Street", Allan Roth, CPA, The Colorado Springs Business Journal

Durable Good Orders Fall

The Department of Commerce reported that orders for durable goods fell -1.7 percent during February, less than the Reuter's consensus estimate of an increase of 0.8 percent. January's number was revised upward to -4.7 percent from a reported -5.1 percent. Non-defense capital goods orders (excluding aircraft) declined 2.6 percent, with January's number being revised downward to -1.8 percent.

Bloomberg news quotes:

"Businesses definitely have shown they are beginning to retrench,'' said Aaron Smith, senior economist at Moody's Economy.com in West Chester, Pennsylvania, in an interview with Bloomberg Television. ``Demand is weakening and investment intentions are showing a bit of fatigue.''

"Recent information indicates that the outlook for economic activity has weakened further,'' (Fed) policy makers said in a statement after the (March 18th) meeting."

All of this seems to be additional evidence that the economy is in a slow down. Below are bullet points from the Duke University/CFO Magazine CFO Survey released March 12th, 2008.

• 54 percent of CFOs say the U.S. is now in recession, and 24 percent of the remaining CFOs say there is a high likelihood of a recession this year. CFOs do not expect the economy to recover until late 2009.

• Optimism reached its lowest point since the optimism index launched six years ago. Pessimists outnumber optimists by a nine-to-one margin, with 72 percent of CFOs more pessimistic and only 8 percent more optimistic about the U.S. economy than they were last quarter.

• Weak consumer demand and turmoil in the credit and housing markets are the top macro-concerns of CFOs. The high cost of labor ranked as the top internal concern.

• Credit conditions have directly hurt 35 percent of companies, through decreased availability of credit and higher interest rates (up 118 basis points on average). Sixty percent of firms have postponed expansion plans in response to credit market unrest.

• Capital spending is expected to increase only 3.3 percent. Price inflation is expected to rise 3 percent over the next 12 months.

Below is a chart from the CFO survey showing CFOs optimism rates for the economy and for their company. They define optimism diffusion as the measures the percentage of CFOs who have increased optimism minus the percentage who have decreased optimism (through March 2008).

Based on their 'optimism' the economy has been in the tank since the 4th quarter of 2004. Their negative outlook predates most of the economic problems that we have currently run into. Did they have some insight into upcoming events or are they just typically negative people?

Source:
"Durable Goods Orders Slip Unexpectedly , Alister Bull", Reuters News
"Orders for Durable Goods in U.S. Unexpectedly Fell", Shobhana Chandra, Bloomberg News
"Global CFO Survey:Recession In 2008, No Relief In 2009", Duke University/CFO Magazine

Declining Home Prices - January

The S&P/Case-Shiller Home Price Index released numbers today showing a continued decline in the price of single family homes across the US. The 10-City Composite index fell to -11.4% over a year, setting another record low, while the 20-City Composite fell to -10.7%. An excerpt from the press release:

“Unfortunately it does not look like early 2008 is marking any turnaround in the housing market, after the declining year recorded throughout 2007,” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor's. “Home prices continue to fall, decelerate and reach record lows across the nation. No markets seem to be completely immune from the housing crisis, with 19 of the 20 metro areas reporting annual declines in January and the remaining – Charlotte North Carolina – eking out a benign 1.8% growth rate. Looking deeper into the data, you can see that 16 of the metro areas are also reporting record low annual growth rates. The monthly data show that every one of the MSAs has now declined every month since September 2007, marking five consecutive months. On top of that, the declines have increased through time, in general, as 13 of the 20 MSAs reported their single largest monthly decline in January.”

I won't bother uploading a chart showing the price decline, but I found some interesting charts/tools on the Macromarkets website.

Looking at the data, unless you were buying homes in certain markets you would have made more money in stocks and commodities over the past five years. If you extend the time frame out to 10 years, real estate does outperform most asset classes. Its not the get-rich-quick-scheme that all those late-night infomercials tried to sell everyone, now is it?

Table comparing the Composite-20 Home price index to other asset classes:

Table comparing the Composite-10 Home price index to other asset classes:

A 10-year chart comparing the Composite-10 Home price index, Boston, Miami & Los Angeles to bonds:

What is interesting is that up until about 2003, the 10 City price index tracked the bond market quite closely. In 2003 the Fed dropped rates to 1.0%. Do you think there is a link between the 1.0% Fed rate and the start of the run-up in home prices?

Source:
'US Home Prices Drop in January', Vinnee Tong, AP
http://www.macromarkets.com/csi_housing/MSA/composite-20.asp

Press Release:
http://www2.standardandpoors.com/spf/pdf/index/CSHomePrice_Release_032544.pdf

Be A Lazy Investor - Part One

Ran across a list of 10 counterintuitive ideas for stock investors. One of the points struck me as being very insightful:

Hard work hurts...(w)orking hard at investing often backfires. Folks diligently research stocks and mutual funds, hoping to earn market-beating gains. But while those gains aren't guaranteed, all the activity may lead to high trading costs and steep tax bills, thus hurting returns.

This axiom goes against everything people are taught. How many times has someone said that if you work hard you will get good grades, or you will be prompted or you will get some other type of reward. This piece of advice seems to go against our very moral fiber as Americans.

But I think that it makes a lot of sense and if followed probably would make things a lot easier when it comes to investing.

It is human nature to think that you are better stock picker than you really are. If most investors accept the fact that they probably just average it could really simplify their investment decisions. Instead of spending hours and hours looking for the next big stock, they could just buy shares in an ETF that invested in the entire stock market. Instead of researching the hottest sector mutual fund, they buy shares in a fund with low expenses and fees.

Source:yahoo.com

Above is a chart for Bear Stearns compared to Vanguard Total Stock Market ETF over the past year. This is a bit of an extreme example of the axiom that Hard Work Hurts. You could have spent a ton of time reviewing the financials of Bear Sterns, invested in it and ended up losing a bit of money, like Joe Lewis, he is down $800 million. If you had just invested in Bear Sterns a year ago, you would have lost 96% of you investment, compared to a loss of 7% with the ETF. Which investment would you have rather been in?

It seems that it would be ideal to develop a portfolio of investments that required very little effort from the investor, yet provide a return that meets or beats the market. I will explore this in an upcoming post.

Source:
"Falling Down the Market Rabbit Hole", Jonathan Clements, WSJ {$$$}

Debit - Not Just A US Problem

Seems that running up a ton of consumer debit is not isolated to the US. Britain has experience a run up in consumer debit levels that exceed those of the US. Britions have a debit to income ratio of 1.62, compared to 1.42 in the US and 1.09 in Germany. Consumer debit in England is greater than its GDP, which estimated for 2007 at $2.2 trillion dollars. The US consumer has run up $13.8 trillion dollars just below its GDP at $14 trillion.

A rather striking passage from a New York Times article:

“The housing boom automatically made people feel richer than they actually were and people went on to use the equity locked up in their property almost as a bank account they can dip into every time they want to buy a new car,” (Liz) Bingham, (head of restructuring at Ernst & Young in London), said.

As the perception of wealth grew, the social stigma around debt disappeared. Borrowing became such an accepted part of life that today one in five teenagers does not consider being in debt to be a bad thing, a survey by Nationwide Building Society showed.

Debt levels increased further as it became easier to get loans, and retailers, like computer chain PC World, offered both goods and the loans to buy them. Consumers happily accepted, thinking that as long as they were deemed creditworthy, they were not in danger of defaulting.

Sounds very similar to the way the US consumer has treated debit.

Its seems strange that if someone thinks or feels that they are rich, they are more inclined to spend money or take on debit. This perception of wealth seems to be rooted in a sense of entitlement and eternal optimism. People have warped their logic so that if they perceive they are rich they are entitled to look or act rich. Or they have been able to rationilze that they can spend the money now, because in the future some how more money will appear. All of which seems to fly in the face of how true wealth is built.

Source:
"Debt-Gorged British Start to Worry That the Party Is Ending", Julia Werdigier, NY Times

Old Maid

Read a good article over the weekend in the Wall Street Journal that interviewed Edward Thorp and Bill Gross some excerpts from the interview:

WSJ: What can your blackjack strategy tell us about how to manage risk in today's markets?

Mr. Thorp: You have to make sure that you don't over-bet. Suppose you have a 5% edge over your opponent when tossing a coin. The optimal thing to do, if you want to get rich, is to bet 5% of your wealth on each toss -- but never more. If you bet much more you can be ruined, even if you have a favorable situation.

WSJ: Bill, you've compared what's going on in the credit markets today to another card game: Old Maid.

Mr. Gross: In Old Maid there's a card nobody wants: the old maid. In today's marketplace, there are quite a few old maids. The ones America knows about are subprime mortgages. And they've spread to, for goodness sakes, the municipal market and sacrosanct areas that presumably are default-free. In Old Maid, you try to pretend to your opponent that you don't have the maid, and you try to entice the other side to pick it up. That is happening extensively in today's market.

WSJ: What's your assessment of the state of hedge funds today?

Mr. Thorp: In the last 15 years or so, there has been a large flow of capital into the hedge-fund world, from $100 billion in the early 1990s to $2 trillion now. But the amount of available investing opportunities hasn't increased that much. That has led to the over-betting phenomenon Bill and I were talking about, or gambler's ruin. Hedge funds started using a great deal of leverage to increase returns. But you can get wiped out if you bet too aggressively. A classic example is Long-Term Capital Management [the huge hedge fund that blew up in 1998]. We'll probably be seeing more of that now.

Mr. Gross: It's true that the available edge has been diminished, and that led to increased leverage to maintain the same returns. It's the leverage, the over-betting, that leads to the big unwind. Stability leads to instability, and here we are. The supposed stability deceived people.

Mr. Thorp: Any good investment, sufficiently leveraged, can lead to ruin

WSJ: But you must feel a little nervous. (Question was in refrence to buying oppurtunites in the bond market)

Mr. Gross: We're treading cautiously, staying with a high level of quality. We're not going into high-yield or the subprime market. Is there blood on the streets? Yes. But there are strong-quality assets out there.

Mr. Thorp: Fear creates opportunities. So as Bill was saying, this is probably a great time.

Source:
"Old Pros Size Up the Game Thorp and Pimco's Gross Open Up on Dangers Of Over-Betting, How to Play the Bond Market", Scott Patterson, WSJ {$$$}

Signs Of A Bear Market And Recovery

Came across a couple of interesting points from a memo sent out by Howard Marks to investors with Oaktree, on the WSJ.com blog page. The memo provides a nice analysis of the current problems the stock & credit markets are having.

The memo outlined the three stages of a bull and bear market:

Bull Market

• the first, when a few forward-looking people begin to believe things will get better,
• the second, when most investors realize improvement is actually underway, and
• the third, when everyone’s sure things will get better forever.

Bear Market

• the first, when just a few prudent investors recognize that, despite the prevailing bullishness, things won’t always be rosy,
• the second, when most investors recognize things are deteriorating, and
• the third, when everyone’s convinced things can only get worse.

The memo also notes:

Certainly we’re well into the second of these three stages. There’s been lots of bad news and writeoffs. More and more people recognize the dangers inherent in things like innovation, leverage, derivatives, counterparty risk and mark-to-market accounting. And increasingly the problems seem insolvable.

One of these days, though, we’ll reach the third stage, and the herd will give up on there being a solution. And unless the financial world really does end, we’re likely to encounter the investment opportunities of a lifetime. Major bottoms occur when everyone forgets that the tide also comes in. Those are the times we live for.

The last two sentences are a great reminder that the market will get better, it just will take time.

Source:
"Bull and Bear Markets, According to Oaktree's Howard Marks", Posted by Peter Lattman

A 5 Star Fund Manager Can't Beat The Market

If a 5 Star fund manager can't beat market, how can you expect to beat the market? Bill Miller, fund manager with Legg Mason Inc, had almost $200 million invested in Bear Sterns with his Legg Mason Value Mutual Fund. As of Thursdays close, the value of the Fund's holding was down to $15 million, a loss of 90%.

Legg Mason Value has hit a bit of a rough patch lately. Since 2006 the fund has lagged the S&P 500. Below is a table of the funds returns:

Investment	YTD (1)	3 Month (1)	1 Year (2)	3 Year (2)	5 Year (2)	10 Year (2)
Legg Mason Value	-17.70%	-17.35%	-9.31%	1.33%	10.83%	7.92%
S&P 500	-9.05%	-9.68%	5.49%	8.62%	12.83%	5.91%

1. Returns as of February 29, 2008
2. Returns as of December 31, 2007
3. Source: Legg Mason

From 1990 to 2005, Bill Miller had beat the S&P 500, and over the inception of the fund it has beat the S&P 500 by 3.72%, annualized. (These returns are through December 31, 2007 and no not account for taxes, fees or expenses.) Towards the end of ever year during the streak, a news story would pop up noting the streak and asking the question 'Will he beat it again?". In 2006 the Fund's streak ended.

So what has changed for the fund? As far as I can tell, Mr. Miller is sticking to his stock picking approach, looking for stocks that are undervalued with good growth prospects. He also maintains a fairly concentrated portfolio, which increases the volatility. As of December 31, 2007 the Value Trust fund held just 48 stocks, with 47% of the funds assets in the top ten holdings.

The fund has almost 40% of its assets in Consumer Services and Financial Services. These two sectors have been hit really hard due to the current problems with the economy. Mr Miller jumped into some of his stock picks too early, and did not anticipate the severity of the credit crisis. This fault is easy to pick up with the benefit of hindsight.

An article in the WSJ notes:

Regarding recent missteps, Mr. Miller is essentially re-employing his strategy from the early 1990s -- an important reference point that's informed some of his boldest buys.

Back then, a similar crisis was unfolding in financial markets and Mr. Miller eventually swooped in to buy money-center banks like Chase Manhattan and Citicorp that he thought were underpriced, as well as insurance companies and mortgage lenders. Financials made up as much as 45% of Mr. Miller's portfolio by the mid-1990s, and helped drive his 15-year winning streak as they rallied over the years.

In his latest shareholder letter, Mr. Miller notes "the past two years are a lot like 1989 and 1990," with a "reasonable probability the next few years will look like what followed those years."

Source:
http://www.leggmason.com/individualinvestors/products/mutual-funds/performance/LMVT.aspx
http://prospectus-express.newriver.com/pnet/get_template.asp?clientid=legg&userid=&fundid=524659109&doctype=pros
http://online.wsj.com/article/SB120605842099153423.html?mod=todays_us_money_and_investing

Additional Reading:
"Where Art Thou Bill Miller", Motley Fool
"Bear Stearns's Demise" Felt by Many Fund Holders", Smart Money
"Stick with Bill Miller", Market Watch

Stock Market Volatility

If you have kept your eye on the stock market lately you may have noticed that it has been extremely volatile. Just within the past week the S&P 500 has closed up 4.20% and had two days where it closed down by more then 2.00%. Below is a chart of the S&P 500.

Source: finance.google.com

Volatility Index

A way that this volatility can be measure is by the VIX, Volatility Index, which is a benchmark index driven by option prices on the S&P 500. The index was developed by the Chicago Board Options Exchange in 1993 and is based on real-tme option prices and measures the expected near term (30-days) volatility of the market. The CBOE explains the index as follows:

VIX is based on real-time option prices, which reflect investors' consensus view of future expected stock market volatility. During periods of financial stress, which are often accompanied by steep market declines, option prices - and VIX - tend to rise. The greater the fear, the higher the VIX level. As investor fear subsides, option prices tend to decline, which in turn causes VIX to decline.

Below is a chart comparing the VIX to the S&P 500 back to January 1990. It is interesting to see the relationship between a decrease in the VIX and increase in the S&P 500 on the last third of the chart. For the past several years, the market has experienced a period of relative calm, or the "Great Moderation." This was a period of time marked by easy credit, real estate became the next bubble, and investment banks developed all types of synthetic securities. It seems that risk left the vocabulary of investors.

Source: cboe.com/VIX

Are We Entering A Period Of Renewed Volatility?

The WSJ had an article which discusses "Great Moderation" and the possibility that we may be entering a period of volatility. The article provides a nice analogy of risk.

That raises the question of whether the idea of a Great Moderation led to its own undoing. As volatility fell, risk-hungry investors and trigger-happy policy makers spent a lot of time patting themselves on the back. Fed officials talked up a more rosy economic landscape and confidently pushed interest rates to historic lows, sure they could fix any problem. Investors witnessed it all and made riskier bets, depending on ever-more debt, to boost their returns.

The compression in volatility was like pushing down on a spring. Now it's sprung. We're probably in the second recession this decade. And the Fed is lowering rates again.

What Is The Average Investor To Do?

For most average investors, there probably isn't anything that you should do. Hopefully, you have determined the level of market risk your are comfortable with and have allocated your investments appropriately. If you have an automatic investment purchase plan set up and a longer time horizon, enjoy the opportunity to buy additional shares at cheaper prices.

If your approaching the time when you will need your money and our uncomfortable with the volatility, look to move your money to more secure investments. With the Fed dropping interest rates, most savings accounts, money market accounts and CDs are barley beating the inflation rate. One option might be to invest in Treasury Bonds or dividend paying stocks. One of the great things about stocks that pay a nice dividend, is that you get pay to wait for any capital appreciation.

Source:
http://www.cboe.com/micro/vix/introduction.aspx
http://www.cboe.com/micro/vix/vixwhite.pdf
http://www.cboe.com/micro/vix/pricecharts.aspx
http://online.wsj.com/article/SB120588597399047123.html?mod=todays_us_money_and_investing {$$$}

Fed Drops Rates...Again

Yesterday the Federal Reserve dropped the Federal fund rate 0.75 percent to 2.25 percent. This was less than the 1 percent people were hoping for. The stock market did not seem to mind, rallying 420.41 points to close at 12392.66. The WSJ notes that the futures market is expecting additional cuts which would bring the Federal Fund rate down to 1.50% to 1.75%.

Since the beginning of this latest round of rates cuts, the rate has dropped from 5.00% to 2.25%. Below is a nice little graphic from the WSJ.com showing the drop in the Federal funds rate & the Discount rate.

Source: WSJ.com

Below is another chart comparing this round of rate drops to other recent easing cycles. The Fed has cut rates quickly dropping 3% points in 120 days. In 2001, the last time the rates dropped this much, it took over 160 days.

Source: WSJ.com

These rate drops are great if you are looking to take out a loan or have a variable rate loan, not to good if you have large amounts of cash sitting in a bank account. Bankrate.com has a series of articles noting the winners and losers of the latest interest rate cuts. They reiterated my point that new borrowers or those with variable rates are the winner and those with cash are losers.

They quote William Larkin, a fixed income portfolio manager at Cabot Money Management in Salem, Mass: "The Federal Reserve has clearly signaled that they're going to throw savers under the bus."

Below is a chart from Bankrate.com showing the drop in national CD and MMA rates over the three months. Not too encouraging for savers.

Source: Bankrate.com

Source:Bankrate.com

With interest rates so low, where do you put your money to work? One place is the stock market. Before yesterday the stock market was approaching the 20% decline that people consider as a bear market. To paraphrase Baron Rothschild the best time to buy is when there is blood in the streets. Below is a chart of the S&P 500 over the past three months.

Source: Yahoo.com

It seems that this post has a nasty habit of inserting graphs that are all going in the downward direction.

Source:
http://online.wsj.com/article/SB120586224310945729.html?mod=todays_us_page_one {$$$}
http://www.bankrate.com/brm/news/fed/winners-losers_Mar182008.asp?s=1&caret=3

Economic Stimulus Payments

The IRS issued a news release providing information on when they will begin sending out the econmic stimulus payments. The IRS will begin to send out the checks on May 2 and expect to be completed with the initial round of weekly payments by early July.

Below are the schedules for economic stimulus payments related to tax returns processed by April 15, 2008.

Direct Deposit Payments
If the last two digits of your Social Security number are:	Your economic stimulus payment deposit should be sent to your bank account by:
00 – 20	May 2
21 – 75	May 9
76 – 99	May 16
Paper Check
If the last two digits of your Social Security number are:	Your check should be in the mail by:
00 – 09	May 16
10 – 18	May 23
19 – 25	May 30
26 – 38	June 6
39 – 51	June 13
52 – 63	June 20
64 – 75	June 27
76 – 87	July 4
88 – 99	July 11

Part of the press release noted that there is an online calcuator to determine if you are eligible for the payments and if so how much you can expect to recieve.

Source:
http://www.irs.gov/newsroom/article/0,,id=180247,00.html

More Good Economic News?

From Bloomberg this morning:

U.S. Unexpectedly Lost 63,000 Jobs in February

The U.S. unexpectedly lost jobs in February for the second consecutive month, adding to evidence the economy is in a recession.

Payrolls fell by 63,000, the most in five years, after a revised decline of 22,000 in January, the Labor Department said today in Washington. The jobless rate declined to 4.8 percent, reflecting a shrinking labor force as some people gave up looking for
work.

``All the lights are flashing red,'' said Nariman Behravesh, chief economist at Global Insight Inc. in Lexington, Massachusetts, in an interview with Bloomberg Television. ``We're in a recession. I don't think there is any doubt about it at this point.''

Monthly Unemployment

Monthly Payrolls

Source: Bureau of Labor Statistics

Another report from the AP:

Carlyle Capital Reports Additional Margin Calls, Considering 'All Options'

LONDON (AP) -- Lenders to Carlyle Capital Corp. Ltd. have begun to liquidate securities held in its $21.7 billion portfolio and the fund said Friday it was considering "all available options."

The margin calls against Carlyle portend an ominous development one day after the fund was served with default notices, convulsing already skittish markets.

...Carlyle Capital said it received additional margin calls and default notices Thursday from banks that help finance its portfolio of residential mortgage-backed securities. It said it may not be able to meet the increased requirements.

The fund said it was unable to meet margin calls from four banks Thursday, raising fears that its entire portfolio could be unwound. Securities have dropped sharply in recent weeks as banks pull back on their lending, forcing investment vehicles and funds like Carlyle to dump assets.

...If the value of the security held as collateral falls, the lender will ask for more collateral, a "margin call", in order to secure the loan. If the borrower does not meet the margin call by putting up more collateral, the lender may sell the security.

Highly leveraged funds have become increasingly vulnerable because their cash cushions are tiny compared with actual assets. Sudden price moves in the underlying assets can send margins spiraling, quickly depleting a fund's cash.

Source: yahoo.com

We have been so focused on the problems in the mortgage market, that a potential larger problem is still lurking out there. When money was easy to get a lot of hedge funds used this easy money, or leverage, to magnify their market bets.

The great thing about this leverage is that it typically takes very little of your own money to put a lot of other people's money at risk. Now those that had extended credit to the hedge funds are starting to become concerned that the money they lent out is worth less now. So they pick up the phone and ask, nicely, that the borrower put up additional money as a sign of good will.

The borrower or in this case a hedge fund typically runs a tight ship and does not keep a lot of extra cash around for this margin call. So they are forced to sell assets in a down market. I could go on, but basically the cycle of margin calls and selling into a down market continue. As the selling continues it spreads to other market sectors not directly affected by the original problems. This could drag on for months, or we could get lucky and a panic break outs.

We have entered a painful period of de-leveraging. I would prefer a panic over a long period of blood letting. Unfortunately too many people are interested in preventing a panic, so expect loses to continue until they stop.

Source:
http://www.bloomberg.com/apps/news?pid=20601087&sid=aJcGRsXmyltU&refer=home
http://biz.yahoo.com/ap/080307/britain_carlyle_capital.html

Declining Homes Prices - Don't Worry Ben's Here To Help

Could not believe this story. I heard it on the radio yesterday but did not pay much attention to it. I thought that there is no way the head of the Federal Reserve would suggest that lenders magically reduce loan amounts for some people who owe more than what their house is worth. But he did, as reported in the New York Times:

The chairman of the Federal Reserve, Ben S. Bernanke, urged mortgage lenders and investors on Tuesday to reduce the principal on loans for many people whose homes are no longer worth as much as the amount they still have to repay.

Noting that delinquency and foreclosure rates have soared over the last year, and that housing prices have not stopped falling, the Fed chairman warned that efforts by the government and by industry to prevent foreclosures had not gone far enough.

“Although lenders and servicers have scaled up their efforts and adopted a wide variety of loss mitigation techniques, more can, and should, be done,” Mr. Bernanke said in a speech to a conference of community bankers in Florida.

Though the Fed chairman did not explicitly endorse a new government rescue effort, he stepped up public pressure on the industry to take more drastic measures to keep people from walking away from homes when their mortgages exceed the value of their property.

“When the mortgage is ‘underwater,’ a reduction in principal may increase the expected payoff by reducing the risk of default and foreclosure,” Mr. Bernanke said. The Fed chairman warned that a large and growing number of recent home buyers now owe more than the value of their homes and may have no incentive to keep making payments.

Seems that Ben and Henry are quite seeing eye-to-eye on this thing. The NY Times article continues:

(T)he Fed chairman’s remarks were at odds with the position staked out in recent days by Henry M. Paulson Jr., the secretary of the Treasury.

Mr. Paulson, who has pushed the industry to freeze interest rates for at least some subprime borrowers whose low teaser rates are about to expire, drew a clear distinction between helping people who could not keep up with rising monthly payments and helping people who, because of falling house prices, had no equity in their homes.

“While these equity considerations clearly impact homeowners’ financial situation, they are not the primary concern in the effort to prevent avoidable foreclosures,” Mr. Paulson said on Monday.

Not sure how writing off principal solves anything except making the problem worse for the mortgage lenders now. If the principal is reduce on a home and lets say the housing market recovers briskly over the next couple of years, when there is a profit on the sale of that home who gets the profit?

Source:
http://www.nytimes.com/2008/03/04/business/04cnd-fed.html

Text of Speech:
http://www.federalreserve.gov/newsevents/speech/bernanke20080304a.htm