Tag Archives: financial advice

Investing Defensively

My Comments: I posted recently that we had better revise our investment expectations downward if we are planning to use our retirement savings to sustain our standard of living for the next twenty years or so.

I attributed the likelihood of lower growth and investment return numbers on demographics and a rising interest rate environment. http://wp.me/p1wMgt-1Qz

The article below by James Hickman is long, full of charts, and technically ripe. You may easily get lost. But he echoes the same message as mine but mostly for those of you who are OK with playing the markets by yourself. If that’s not you, there are other ways to be defensive.

Below is his introduction to Part I of II. If you click on his name, you’ll also find Part II.

May 31, 2017 \ James Hickman

Retired Or Retiring In Next 15 Years? Better Get Defensive (Part I Of II)

Summary

  • Market timing is sensible in certain circumstances – like reducing US equities exposure now.
  • Always passively invest in public equities and fixed income – not alternatives – but asset allocation still requires active approach.
  • Financial healing power of “the long-term” is no remedy for max drawdowns in the retirement plan homestretch.
  • Portfolio implications of 3% ROI for another decade, 2% US GDP forever.

“Market timing is a loser’s game” is a misleading marketing slogan peddled by the long-only mutual fund machine. The mass cash movements in and out of public equity markets that cause market timing failure are rarely driven by disciplined, value-based decisions about asset allocation but rather by emotional investor capitulation to protracted trends at precisely the wrong times. The trite phrase is invariably trotted out when markets are most over-valued and risky – when investors should be selling but rarely are. Now is one of those times.

Recognizing that you should always use low-cost, passive vehicles in certain asset classes and pay for skill in others is not news. But the more important question is: How much should be allocated to each asset class? Asset class and investment strategy exposures, beyond just equities and fixed income, is critical to portfolio diversification and return variation (Brinson, Hood and Beebower – 1986; and Xiong, Ibbotson, Idzorek and Chen – 2010). But can asset classes be timed? The answer is yes.

The professional investment industry has always been animated by failed attempts to systematize alpha generation – to create a better mousetrap for delivering repeatable outperformance of the market and justify higher active management fees. Active managers continued their interminable streak of underperforming the broader markets in 2016. According to S&P Dow Jones Indices’ SPIVA US Scorecard for 2016, “Over the 15-year period ending Dec. 2016, 92.15% of large-cap, 95.4% of mid-cap, and 93.21% of small-cap managers trailed their respective benchmarks.”

This Is Not How A Bear Market Starts

My Comments: Today is Memorial Day, and the markets are closed in this country. It’s a day for us to instead remember those of us who gave their lives that we might continue with ours. Pray that fewer lives will be given in the years to come.

The following comes from someone whose name I do not know. But if you can wade through the math and graphics, you may find that the world is not about to end. At least financially.

Here’s how the author describes himself: “I have a degree in Math and Science from the University of Toronto, as well as a degree in education, also from U of T. I have traded private equity for 38 years and have developed a proprietary Price Modelling System which has provided me with consistent profitable trading success. In partnership with my computer scientist son, Aidan Gomez, we have automated this model using neural networks, and offer a Trade Alert service that lets subscribers replicate the trades we are involved in.”.

To see the charts, you’ll want to visit the source article HERE.

May 22, 2017 | ANG Traders

Summary
There has been much digital ink spilled trying to convince us that the bull market is on its last legs.

We present fundamental and technical reasons to support the idea of an ongoing bull market.

Black swans aside, this is not how bear markets start.

There has been, and continues to be, an inordinate amount of digital ink spilled promulgating the imminent demise of the bull market. Most of the arguments for this, center around the near-historic levels of certain metrics, such as PE ratios and S&P averages, but they ignore the factors that truly coincide with the launch of bear markets. In this piece, we will attempt to elucidate several of the metrics that we have correlated with bear or bull markets, and hopefully, show that the bull market is alive and well.

Rate Differential
When the 10-y minus the 2-y Treasury rate inverts, it has a way of marking the end of bull markets. When this differential turns negative, in conjunction with low unemployment, investors should look for an exit. Today, the unemployment rate is low, but not as low as in 2000 or 2007, and the 10-y minus 2-y rate is still a healthy +1%. It will take several sizable Fed rate hikes before the rate differential inverts (chart below). This does not look like the start of a bear market.

Fed Funds Rate

It is obvious that when the Fed raises rates, the bull market dies, but often when it comes to the market, what is obvious, is obviously wrong. In fact, three of the last four bull markets occurred while the Fed raised rates – the latest bull market being the exception (chart below). The Fed has lots of room to raise into a growing business cycle. Bear markets do not start when low rates are being raised.

Industrial Production
Except for a five-month period in 2002, a rising industrial production has coincided with a rising SPX. The chart below demonstrates this strong positive correlation. Bear markets do not start with rising industrial production.

GAAP Earnings

The Generally Accepted Accounting Principles (GAAP) earnings enjoy a positive correlation with the S&P 500. The GAAP earnings started rising two quarters ago, and the current quarter is shaping up to be positive also. Bear markets do not start with rising GAAP earnings.

Technical Indicators
The 8-month moving average remains above the 12-month moving average, the MACD is rising, the ADX is displaying a bullish pattern, and the RSI and stochastic are elevated, but they can remain elevated for long periods of time (chart below). This is not how bear markets start.

Investor Sentiment
Bull markets climb the proverbial “wall of worry.” There is a lot of geopolitical and intramural politics to worry about, and which are feeding the bull market. Bear markets do not start when there is fear around. They start when investors are confident and throw caution to the wind. The AAII investor sentiment indicator stands at a fearful 24% bullish sentiment, and 34% bearish sentiment (red and blue arrows respectively on the chart below). Bear markets start when bullish sentiment is over 50%, and bearish sentiment is under 30% (red and blue oval on the chart below). This is not how bear markets start.

In conclusion, the evidence presented paints a picture of a bull market that is still fearful and healthy. That is not to say that a black-swan won’t fall out of the sky and ruin the picnic, but judging from what we can and do know, a bear market is not imminent.

Social Security Rules

My Comments: For millions of us, Social Security is critical for keeping our heads above water. If you are just now entering the transition to retirement, what you read here is basic information you need to be aware of.

Wendy Connick / May 12, 2017

Calculating your Social Security benefits can get…complicated. It’s not just a matter of looking at the number on your Social Security statement and figuring that’s how much you’ll get. A number of different rules will have an impact on determining your final, actual benefit check, so it’s important to understand these rules and how they may affect your benefits.

Rule No. 1: Your base benefits are determined by your 35 highest-income years

When calculating your benefits, the Social Security Administration only looks at your 35 highest-income years. If you worked more than 35 years, the rest of your work history (and the money you paid into Social Security) simply doesn’t count toward your benefits calculation.

Rule No. 2: Social Security retirement benefits come in three flavors

Setting aside disability benefits, there are three kinds of Social Security benefits paid out during retirement: basic retirement benefits, spousal benefits, and survivor benefits. Retirement benefits are based on your earnings; spousal benefits are based on your spouse’s or ex-spouse’s earnings; and survivor benefits are based on your deceased spouse’s earnings. Spousal benefits can be up to one-half of your spouse’s full retirement benefits, while survivor benefits can be up to your deceased spouse’s full retirement benefits.

Rule No. 3: You can’t get both spousal and retirement benefits

If you are eligible for spousal benefits and standard retirement benefits based on your own earnings, you can’t get both types of benefits — you can only claim one. If your spouse earned significantly more than you did, this could result in your never actually getting your own retirement benefits.

Rule No. 4: Taking benefits early will cost you forever

If you start taking your Social Security benefits before “full retirement age” (which is typically either age 66 or 67, depending on your birth date), then your monthly benefit amount will be permanently reduced. Start taking benefits at age 62, the earliest possible start date, and your benefits will be reduced by as much as 30% for the rest of your life.

Rule No. 5: Claiming your benefits late results in larger monthly checks

If you wait until after full retirement age to claim your Social Security benefits, your monthly benefit check will increase by 8% for every year you wait. However, these credits stop accruing once you hit age 70 — meaning that it doesn’t make sense to wait longer than that to claim your benefits.

Rule No. 6: Working while receiving Social Security benefits may reduce your benefit checks

If you earn more than $16,920 per year (in 2017) while also receiving Social Security benefits and are under full retirement age, your benefits will be reduced by one dollar for every two dollars that you earn above this base amount. Once you’re above full retirement age, your earnings will no longer limit your benefits. What’s more, the Social Security Administration will credit you for the benefits you didn’t receive in previous years due to earning extra money, and will add that amount to your future benefits.

Rule No. 7: Social Security benefits are capped

For 2017, if you claim your Social Security benefits at full retirement age, the most you can get is $2,687 per month. You’ll get the maximum if your Average Indexed Monthly Earnings during your 35 highest income years was at least $8,843 (indexed means that your earnings are weighted to account for inflation). If you wait until age 70 to claim your Social Security benefits, then the most you can get in 2017 is $3,538 a month. The average Social Security benefit for 2017 is $1,360 per month.

Rule No. 8: Your Social Security benefits may be taxed

If one half of your Social Security benefit plus your other taxable income for the year plus nontaxable interest is equal to or greater than $32,000 (for married filing jointly) or $25,000 (for unmarried taxpayers) then your Social Security benefits will be partially taxable. Just how much of your Social Security benefits will be taxed depends on how much taxable income you have for the year. Nontaxable income, such as distributions from a Roth account, doesn’t count toward this threshold.

Putting it all together

It’s best to get familiar with the Social Security rules well before you’re ready to retire. If you wait until you want to start claiming benefits, you may miss some important opportunities to bump up your benefits. Still, it’s better to learn these rules late than to never learn them at all.

Asset Allocation Strategies That Work

My Comments: It’s not easy to make your money grow. And to make sure once it’s grown, it doesn’t disappear.

A long time truth involves a principal called asset allocation. It means spreading your money across different styles and kinds of assets. Some will always work better than others, not just when going up, but when going down also.

A good asset allocation mix perhaps means not hitting a home run, but also not striking out.

By Jason Van Bergen / January 2017

Establishing an appropriate asset mix is a dynamic process, and it plays a key role in determining your portfolio’s overall risk and return. As such, your portfolio’s asset mix should reflect your goals at any point in time. Here we outline some different strategies of establishing asset allocations and examine their basic management approaches.

Strategic Asset Allocation
This method establishes and adheres to a “base policy mix” – a proportional combination of assets based on expected rates of return for each asset class. For example, if stocks have historically returned 10% per year and bonds have returned 5% per year, a mix of 50% stocks and 50% bonds would be expected to return 7.5% per year.

Constant-Weighting Asset Allocation
Strategic asset allocation generally implies a buy-and-hold strategy, even as the shift in values of assets causes a drift from the initially established policy mix. For this reason, you may choose to adopt a constant-weighting approach to asset allocation. With this approach, you continually rebalance your portfolio. For example, if one asset is declining in value, you would purchase more of that asset; and if that asset value is increasing, you would sell it.

There are no hard-and-fast rules for timing portfolio rebalancing under strategic or constant-weighting asset allocation. However, a common rule of thumb is that the portfolio should be rebalanced to its original mix when any given asset class moves more than 5% from its original value.

Tactical Asset Allocation
Over the long run, a strategic asset allocation strategy may seem relatively rigid. Therefore, you may find it necessary to occasionally engage in short-term, tactical deviations from the mix to capitalize on unusual or exceptional investment opportunities. This flexibility adds a market timing component to the portfolio, allowing you to participate in economic conditions more favorable for one asset class than for others.

Tactical asset allocation can be described as a moderately active strategy, since the overall strategic asset mix is returned to when desired short-term profits are achieved. This strategy demands some discipline, as you must first be able to recognize when short-term opportunities have run their course, and then rebalance the portfolio to the long-term asset position.

Dynamic Asset Allocation
Another active asset allocation strategy is dynamic asset allocation, with which you constantly adjust the mix of assets as markets rise and fall, and as the economy strengthens and weakens. With this strategy you sell assets that are declining and purchase assets that are increasing, making dynamic asset allocation the polar opposite of a constant-weighting strategy. For example, if the stock market is showing weakness, you sell stocks in anticipation of further decreases; and if the market is strong, you purchase stocks in anticipation of continued market gains.

Insured Asset Allocation
With an insured asset allocation strategy, you establish a base portfolio value under which the portfolio should not be allowed to drop. As long as the portfolio achieves a return above its base, you exercise active management to try to increase the portfolio value as much as possible. If, however, the portfolio should ever drop to the base value, you invest in risk-free assets so that the base value becomes fixed. At such time, you would consult with your advisor on re-allocating assets, perhaps even changing your investment strategy entirely.

Insured asset allocation may be suitable for risk-averse investors who desire a certain level of active portfolio management but appreciate the security of establishing a guaranteed floor below which the portfolio is not allowed to decline. For example, an investor who wishes to establish a minimum standard of living during retirement might find an insured asset allocation strategy ideally suited to his or her management goals.

Integrated Asset Allocation

With integrated asset allocation, you consider both your economic expectations and your risk in establishing an asset mix. While all of the above-mentioned strategies take into account expectations for future market returns, not all of the strategies account for investment risk tolerance. Integrated asset allocation, on the other hand, includes aspects of all strategies, accounting not only for expectations but also actual changes in capital markets and your risk tolerance. Integrated asset allocation is a broader asset allocation strategy, albeit allowing only either dynamic or constant-weighting allocation. Obviously, an investor would not wish to implement two strategies that compete with one another.

Conclusion
Asset allocation can be an active process to varying degrees or strictly passive in nature. Whether an investor chooses a precise asset allocation strategy or a combination of different strategies depends on that investor’s goals, age, market expectations and risk tolerance.

Keep in mind, however, that this article gives only general guidelines on how investors may use asset allocation as a part of their core strategies. Be aware that allocation approaches that involve anticipating and reacting to market movements require a great deal of expertise and talent in using particular tools for timing these movements. Some would say that accurately timing the market is next to impossible, so make sure your strategy isn’t too vulnerable to unforeseeable errors.

Source article — http://www.investopedia.com/articles/04/031704.asp

An Overvalued Stock Market?

My Comments: Dr. Doom here again. And boy, do I love this first chart. Many of my colleagues have been encouraging our clients to sit on the sidelines now for about two years or more. And we’ve been blasted because the DOW and the S&P just keeps going up.

Unless you believe the world has been reinvented, it will turn down. At least for a while. And if you have money critically placed to help you in your retirement, my suggestion is to play the odds that the market will turn against you.

There are ways to protect yourself and still make money, but that’s for another day when I change from Dr. Doom to Mr. Happy.

Steve Hunt | April 12, 2017

Since Donald Trump became the 45th president of the United States of America, the S&P 500 has jumped more than 8%. However, at least five different major financial indicators, along with a chorus of financial experts, agree: The stock market is alarmingly overvalued.

We’ve seen these historical moments before: a great boon before a great crash. President Coolidge’s era of excess in the 1920s led directly to the Great Depression. The dotcom boom in the 1990s was followed by a recession. The mortgage bubble burst us into the 21st Century’s Great Recession.

In March 2009, the S&P bottomed at 666. Today it’s trading around 2,300. This marks one of the longest bull markets in history, sparked largely by the Federal Reserve’s low interest rates. In the last decade, the Fed has shouldered a massive amount of debt to keep the economy afloat after the housing crisis, rolling out multiple rounds of quantitative easing. The national debt doubled between 2007 and 2017, from $9.2 trillion to $18.9 trillion.

Moreover, the Committee for a Responsible Federal Budget, a non-partisan group advocating for responsible government spending and debt reduction, predicts that the federal budget could increase by $5.3 trillion in the next decade, raising the deficit by as much as 25%.

Still, consumer confidence was at a 16-year high in March. Investors appear to be displaying optimism for the American economy by investing in stocks, an attitudinal response to President Trump’s rhetoric of unbounded economic expansion.

Unfortunately, the surge in the stock market does not reflect an economy grounded in reasonable economic growth. Financial strategist Michael Pento points out that historically, a recession has occurred in the U.S. about every five years and we’re long overdue.

Generally speaking, when the stock market is overvalued at the extreme levels we are seeing now, a sharp reversal occurs. The bubble bursts. The last time stocks were identified as being riskier than they are now was in 1929 and 1999.

Here are five financial indicators that show an overvalued stock market.

1. According to CAPE the Stock Market Is Overvalued By 75%
Case Shiller’s cyclically adjusted price-to-earnings (CAPE) ratio is a widely respected valuation measure of the U.S. S&P 500 equity market, originated by Nobel Prize-winning economist Robert Shiller. Though CAPE shows the stock market as overpriced since the 1990s (the 10-year CAPE average is 16, meaning that for every $1 a company makes, an investor pays $16), it hasn’t been this high since 2002 and 2007, directly before the last two crashes. For reference, the ratio was at 45 before the dotcom bubble burst in 2002. As of April 11, 2017, the ratio stood at 28.75.

Shiller recently warned against the dangerous “narrative” sparked by the Trump administration. Markets are rising based on unrealistic optimism over future prospects, despite the fact that the market bubble resembles the days leading up to the 1929 crash. Shiller warns that “something is not quite right with the supposedly strong and expanding U.S. economy.”

2. Corporate-Equities-to-GDP Ratio Is At Third-Highest Point in History
There are two primary “Warren Buffet Indicators,” named as such because the famous billionaire identified them as his favorite market valuation tools. One measures corporate equities against gross domestic product (GDP) and the other measures market-cap to GDP.

In December 2016, Wall Street jumped to 27.9 times the corporate earnings of the past 10 years, which registers as extreme on CAPE. It’s only been higher twice since 1950 – in 1999 at the height of the dotcom bubble and in late 2015. As of March 2017, the corporate-equities-to-GDP ratio was 125.3.

3. Wilshire 5000-to-GDP Ratio Is At Third-Highest Point in History

The Wilshire 5000-to-GDP is Buffet’s other favorite indicator – a market-cap weighted index of all U.S.-headquartered stocks traded on the major exchanges. A reading of 100% shows stocks valued fairly – anything over that reflects stock market overvaluation. The Wilshire index as a percentage of U.S. GDP is at 130%, much higher than the 45-year average, which stands around 75%.

4. Goldman Sachs S&P 500 Valuation Shows Stocks Overvalued By 88%
According to Goldman Sachs’ valuation of the S&P, the market is in the 88th percentile on an aggregate basis and in the 98th percentile on a median basis.

5. BofA S&P 500 Valuations Show Stocks Overvalued on 17 Out of 20
As of December 2016, Bank of America showed that the S&P is above average prices along 17 different measures, with overvaluation standing at more than 20% for nine of those.

Looking at the data across these five different metrics, it would be hard to make an evidence-based case for an accurately valued stock market. Instead, what some analysts are calling “Trump hope” seems to be spurring the rush into the rising S&P. It might be weeks, or it might be months or years, but at some point there’s a whole lot of hurt waiting to happen.

Considering the larger picture of growing consumer and national debt, paired with continuing global and civil tensions, the S&P’s performance is an incomplete picture at the very least and a red flag of looming economic collapse at the very worst. Either way, investing too heavily in rising stocks now could easily be considered a bold display of misplaced confidence

Stock Pickers vs Indexers

My Comments: Which approach is best for you? Not for me, but for YOU?

For the past dozen years or more, my efforts on behalf of clients to use historically good fund managers has largely failed. And not just because of what happened in 2008-09.

Yes, I still made my money as an advisor. But increasingly I couldn’t justify it in terms of the results. Many clients, listening to the likes of Jim Cramer on TV, decided they could get better results elsewhere. I hope they were successful but the odds were not in their favor. If you follow the link below, you’ll better understand why I say this.

My approach today is to use one of the two major global index families and either give away my advice to those who will accept it, or charge what a few years ago was considered a ridiculously low fee. Some people just have absolutely no capacity to figure it out for themselves which is what gives people like me a license earn an income.

Clients have two basic choices: either do it all yourself, of find someone to help you. Regardless of that decision, the next step on the decision tree is how much unprotected exposure to the stock, bond and other markets can you live with.

The trauma from the crash in 2008-09 is still very much alive in peoples minds. To the extent you want exposure to the markets and at the same time protect your downside, there are some very clear solutions. To the extent you are OK with watching your assets crash and burn, indexes at least eliminate most of the management costs. This is a good thing.

Either way, I can sleep at night and not feel like caveat emptor is the ruling maxim.

Why Reducing Investment Losses Is So Important

My Comments: There are times to be cautious and there are times to throw caution to the winds. As you get older, caution is increasingly common.

One way to solve your dilemma is to focus efforts on limiting what we call downside risk. That’s the opposite of upside risk for those of you just figuring this out. Most people have no problem with the upside. I’ve never had a client pissed at me for helping them make a lot of money.

However, for the past two plus years, it’s been elusive. There is a remedy but first, let’s set the stage for controlling downside risk. This idea become increasingly critical in retirement when you start using your retirement savings to pay bills.

Raul Elizalde  |  April 6, 2017

Investing in stocks can be brutal. According to research, the S&P 500 lost at least 10% from a previous high every two-and-a-half years on average, and at least 20% every six. A 30% loss happened every 13. It has fallen 50% from a peak three times since 1954. Remarkably, losses of this magnitude contradict the models we use to describe market behavior.

For example, the largest S&P 500 one-day loss was 20.5% in October 1987. According to a widely used model of stock market returns (which assumes they form a bell curve around an average), the likelihood of the 1987 loss is roughly equivalent to picking the right card in a deck with as many cards as atoms in the known universe. In other words, that loss could not have happened.

Limit Your Losses When the Market Drops

Clearly the problem is not that impossible events happen; it is rather that our models are inadequate, and a lot of analysts have tried to come up with better ones. So far, this quest has proven fruitless. We still can’t predict markets with any meaningful accuracy. This is why markets are not so much like the weather, but rather like earthquakes, which scientists now admit are unpredictable.

But here is the good news: we cannot predict earthquakes, but we know how to build earthquake-resistant structures. Likewise, we cannot predict markets, but we have techniques that can help us limit losses when markets tank. There are some very basic reasons why limiting losses is more important than producing strong returns.

A well-known example goes like this: If you lose 50% of $100 you need a 100% return on the remaining $50 to break even. This means that a large percentage loss requires a very large percentage gain for full recovery.

But a far more important example is this: If you only lose 20% of $100, you will need just 25% to bring the remaining $80 back to $100. So a small loss requires much less effort to come out from it.
Limiting Losses Even More Important in Retirement

This is even more important for retirees who use savings to pay for living expenses.

For example, taking $10 after a portfolio falls from $100 to $50 leaves the saver with only $40. A subsequent 100% return only takes the portfolio back to $80. That means that the $10 withdrawal turned into $20 because of its bad timing.

But when $100 only falls to $80 and $10 are taken, a subsequent 25% recovery on the remaining $70 brings the value up to $87.50. This means that the $10 withdrawal turned into $12.50—a much smaller penalty for taking money out at the worst possible time.

The moral is clear: limiting losses is an essential element in portfolio management.

How to Limit Losses

Limiting losses requires some basic processes in place. The best known is diversification, or investing in a mix of assets that tend to move in different directions. But a mix that looks diversified today may not be diversified tomorrow, especially when markets take a turn for the worse. This is because in down markets investors sell everything and correlations go up sharply. Therefore, a mix that does not take into account how the market cycle changes is prone to go through periods where diversification goes away just when investors need it most. Adapting portfolios to market conditions requires dedication, patience, and a well-designed set of rules.

This is, or should be, the professional portfolio manager’s job. Some investors insist that the portfolio manager’s job is simply to beat the market by picking a high proportion of winning assets. Accordingly, they are willing to pay a premium for those managers who seem to have the hot hands. This is a bad approach, commonly known as “chasing past returns.”
Many studies show that virtually no active fund can consistently beat its benchmark, and not because of fees. According to Standard & Poor, which publishes a regular analysis of fund performance, most funds underperform their benchmarks both before and after fees.

The simple explanation is that poorly diversified funds can only outperform their benchmarks through superior forecasting. But, just like for earthquakes, forecasting the market accurately is impossible. As one academic put it:

Going back to basics, the idea “to invest successfully in the stock market, you need to know whether the market is going to go up or go down” is just wrong. (Professor David Aldous, UC Berkeley – The Kelly criterion for favorable games, Lecture 2)

While limiting downside exposure is crucial in portfolio management, having this protection in place at all times can be frustrating. If the market keeps on rallying, the “insurance” against declines may appear to be an unnecessary drag on returns, just as going through the expense of building a house that is earthquake-resistant may seem like a waste as long as there are no earthquakes.

We have all complained about paying for insurance that we don’t seem to need. This is understandable as long as disaster does not strike. But the temptation to cancel insurance can be dangerous. If you are not yet convinced this is so, please reread the first paragraph to see why having a systematic process to protect investments from losses is a good idea.