Good Investing Commentary -- Wanted to Share

Here's a brief, well written market review that I receive for free each month (for the month of October): Monthly Market Review - October 2009

I don't recall how I came across this review, but aside from being a great resource, it's tied to some really well done marketing for Agile Investments, which is an ETF Portfolio Management organization. These groups have been popping up relatively frequently, and are worth investigating if your looking for someone to manage a set of ETFs to support an index investment approach.

2009 Index of Economic Freedom

Yesterday's WSJ featured an Op Ed presenting this year's Heritage Foundation/WSJ Index of Economic Freedom, which can be accessed here: http://www.heritage.org/index/

This index is intriguing, and is a great tool that is useful in a number of ways. If you haven't seen it, take a look.

One contention that Terry Miller (one of the co-editors) makes is that there is a strong "positive correlation between economic freedom and national income". As proof, he points out that "...the freest countries enjoy per capital incomes over 10 times higher than those in countries ranked as "repressed"."

So what do you think?

Some tidbits worth exploring:

• The methodology: http://www.heritage.org/index/pdf/Index09_Methodology.pdf
• The executive summary: http://www.heritage.org/index/pdf/Index09_ExecSum.pdf

Buffett's Opinion in the New York Times

In last week's NYT, a great opinion piece by Warren Buffett: http://www.nytimes.com/2008/10/17/opinion/17buffett.html?_r=1&oref=slogin

As part of his opinion, Warren makes a number of important points, which I want to summarize for you here:

1) No one can determine the direction of the market
2) Betting against America is a mistake
3) Holding cash vs. equities long-term is a bad decision

Now to this last point, I'll pull a couple of comments directly from Warren, and tie it to some recent research from the AAII, which indicates that those that face retirement need to remain in equities to meet their long-term retirement needs.

As Warren states:

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

So, congratulations to those that had the foresight to move into cash prior to the crisis, but the question for them now becomes "When do I get back in?" ---And the real key to success in investing is to know both when to buy AND when to sell. Warren approaches this in an important way, by simply owning the stocks "forever". For those of us that don't necessarily feel like we have that luxury,it's still instructive.

Now to reference a study mentioned in January's AAII (American Association of Individual Investors) Journal article "Choosing the Right Mix: Lessons From Life Cycle Funds ". Although the article is about life cycle funds, it discusses a "consensus opinion" on asset allocation, which follows:

Allocation by Age Group:

• Ages 20 to 40: Allocate about 90% of your financial portfolios to stocks.
• Age 40 to retirement: Decrease the stock portion steadily to about 50% or 60%.
• During retirement: Decrease the stock allocation by 2% per year for at least the first five years after retirement; high-yield bonds should be only a small fraction of the fixed-income portfolio.
• All ages: Maintain a stable exposure to international stocks of between 15% and 30% of the stock portfolio.

For some, this suggested allocation may seem excessive. Beginning retirement with 50-60% of your investments allocated to stocks? Yes. The logic is this -- the most significant investment gains come from the compounding of investments that takes place in later years.

Warren at 70+ years knows this inherently, yet it's a lesson that some retirees will need to take to heart, and unfortunately, it will mean increasing the risk they will have to bear. For those that are currently tied in equities within this market, they may have no other choice.

On Buffett...

Ah, Warren Buffett. In addition to investing philosophy, what can he teach us? How about fact-based decision-making and the art of contingency:

http://online.wsj.com/article/SB122403066764234719.html

In Carroll's review of "The Snowball", a biography of Warren Buffett by Alice Schroeder, she walks through Buffett's ability to take "a close look at an investment's intrinsic value, making a brutal evaluation of its risks, and calculating a margin of safety. The book also underscores the importance of learning from failures. The Buffett-Munger approach is to "invert, always invert. Turn a situation or problem upside down. Look at it backward. What's in it for the other guy? What happens if all our plans go wrong? Where don't we want to go, and how do you get there? Instead of looking for success, make a list of how to fail instead."

A great way to look at investing --- and any other problem for that matter...

Obama and the capital gains tax

I don't talk politics on this blog, that's simply not its intent. I do, however, speak about economics on occasion, and even tax policy, and that's what I'll do here. Although I won't share my preference for the presidential race, this post will point you to a commentary referencing Barack Obama's stated views on taxation from the most recent Democratic presidential debate, from yesterday's WSJ: http://online.wsj.com/article/SB120847505709424727.html.

Although Barack (and Hillary) have both indicated that they will not raise taxes on households that make under $200 - $250k a year, both are talking about raising the capital gains tax, which does indeed raise taxes, and impacts over 100 million households directly (including mine). In addition a higher tax rate, the real kick in the pants is the fact that an increase in this tax actually reduces overall tax revenue, which directly undermines the overall goal of the tax in the first place. As the commentary reveals:

• Lower capital gains taxes actually increase tax revenues considerably (this is because lower rates stimulate liquidity throughout various asset classes).
• 79% of all tax returns reporting capital gains came from households with incomes below $100k.

These are facts gleaned from actual results of former tax policy and '05 tax returns (most recent data available?). The commentary closes with an explanation of Obama's additional desire to raise the cap on wages subject to payroll tax beyond the most recent '07 cap of $102k .

Unfortunately, as WSJ suggests, "Either the young Illinois senator is ignorant of capital gains data, or he just doesn't care..." Here's to hoping he refines this policy before the presidential election takes place.

Take your Lump Sum Pension now!

Ok, so I'm still mulling through that Forbes issue from the last post, and it's lucky that is the case because as I consider my separation from ABN AMRO/LaSalle - it could help me save a decent amount of $$$$, and you too, for that matter.

The issue ---- pension valuation. The rules are changing in a way that will minimize the value of your pension over time. If you are one of the lucky few within the US to still have a pension, you'll want to take a closer look at this article: http://www.forbes.com/personalfinance/forbes/2008/0225/048.html

The skinny: Congress is allowing companies to lower the estimated earnings calculation that is made as pension benefits are calculated. As these estimates are lowered, the resulting amount that your company owes you decreases. If you have an opportunity to act before this legislation take effect - you should take it.

Retirement and your 2007 tax strategy

Great article in Forbes on tax advantaged ways to save: http://www.forbes.com/forbes/2008/0225/040.html?partner=email

Very good summary that will help you:
- understand your retirement savings options quickly
- determine how to prioritize those options

Of note - discussion about best location for various assets, based on the type of income they will generate. Highest growth assets belong in a Roth, while taxable bonds and REITs belong in a pretax 401k or IRA (since the income that generate is taxed at ordinary rates, you want to defer it as long as possible).

Another reason to move to ETFs

If what you've already seen hasn't convinced you about the value of ETFs, here's yet another argument: http://online.wsj.com/article/SB118704344974996454.html.

The article is specific to index ETFs, and the message is simple, take a close look at annual expenses --- they should be low. When your investment tracks a specific index, the fund manager should be able to effectively reduce expenses. According to the article, this reduction is somewhat of an art. One fund specifically mentioned, Fidelity Spartan 500 Index Fund. Take a look and let me know what you think.

Spin-off Opportunities

In addition to some merger arbitrage opportunities I've been evaluating, I would also like to alert you to "spin-off" situations where value is often created. One authority on this subject is Joel Greenblatt and his first book is a great introduction to this topic. In addition to being an extremely successful hedge fund investor, he's also an adjunct professor at Columbia Business School, the home of "value investing".

Without going into too much detail here, spin-offs can be attractive investment opportunities because it usually takes the market a while to accurately value the two companies that result from a situation like this. I just ran across a good example below, which is a brief description of the Metavante spin-off being conducted in Q4 by Marshall & Isley bank (of Milwaukee).

Take a look: http://www.businessweek.com/magazine/content/07_34/c4047055.htm#ZZZRY42U45F.

More on market correlations...

So, does investing internationally or across financial instruments shield you from losses? While diversification across asset classes and/or international markets was once seen as an accepted way to reduce risk, now there is debate about whether this strategy will really protect investors: http://online.wsj.com/article/SB118635012472388580.html?mod=mkts_main_news_hs_h.

As I note, here http://marketlevers.blogspot.com/index.html#7777250631725150197 and here http://marketlevers.blogspot.com/index.html#2178961660242578272, investing globally has historically had diversification benefits relative to the the S&P, but as the ubiquitous disclaimer states "past performance is not a guarantee of future results".

ETF Investing: A Basic Framework

As I've mentioned in previous posts, ETFs (exchange traded funds) can be a compelling investment option for individual investors looking to minimize fees and diversify their portfolios in specific ways. Today's WSJ provides a great summary of how financial planners have embraced these new tools, including information on the "core holdings" that most select for their clients. It's a great starting point for those of you considering a move to ETFs.

Link: http://online.wsj.com/article/SB118591511495683793.html.

Quick pro/con points discussed on ETFs (from this article and others):
- Pro: As the article points out, as opposed to mutual funds, an investor always knows the underlying securities within an ETF. While this is true, as I've researched these individually (e.g. Vanguard REIT ETF), sometimes it takes more than a look at a prospectus to get this data.
- Pro/Con: ETFs are easy to get in and out of, i.e. you don't have to wait until a specific window to trade them, and there are no front or back-loaded fees. While this is a benefit in the sense that it minimizes trading costs, some point out that it can make investors more prone to trading "in and out" of these investment as they try to time the market --- not a good idea.
- Pro/Con: These investments can be "shorted", in other words, you can "sell" shares that you don't own and then buy them back at a lower price later if you think they will decline. Again, not a technique for every investor, but a powerful feature that mutual funds lack.

Although I won't get into the details of the core holdings (see the article) or extended portfolio, here's a quick run-down of those I liked. Based on research I've done as I've watched this space for the past five years, these are solid recommendations for a long-term investor:

Core (by ticker):
SPY
RSP (my favorite)
PGJ
EFA

Extended:
IWM
VNQ
VWO

Investment Advice - James B. Stewart

This is just a quick recommendation for James Stewart, a weekly columnist for both Smart Money and the Wall Street Journal. He's got a very good, common sense approach to investing that I've grown to admire and have alluded to or directly addressed here on occasion.

Here's an archive of his recent articles, including his take on the Wild Oats acquisition and when to buy and sell stocks: http://www.smartmoney.com/commonsense/index.cfm?story=archive&nav=wsjpj.

Merger Arbitrage

As the U.S. credit market starts to tighten, investors continue to express their view that some proposed mergers may not actually end up taking place. These lower probabilities are being reflected in the difference between the current price of several target companies and their "tender"/merger offer price. This difference is known as the "deal spread". Savvy investors can use these opportunities to buy good stocks at a discount, and earn the money in the middle - via "arbitrage".

A Merger Arbitrage Example
A good example is the proposed acquisition of Wild Oats Supermarkets by Whole Foods. Although Whole Foods is currently offering shareholders an $18.50 a share price to purchase the shares, the shares are currently trading at $16.10 (13% less than the offer price). In large part, this discount reflects the uncertainty surrounding the FTC's current antitrust actions against Whole Foods.

An interesting question, how does a $565MM acquisition dramatically change the competitive environment for companies like Safeway (SWY), which is a 14 billion dollar company? Answer: It doesn't. The funny thing is, although this has been noted in the media and by antitrust experts, the discount persists. An opportunity to pick up 13% --- I think so.

Some other examples, courtesy of Goldman:
For more interesting arbitrage examples, see this WSJ article from today: http://online.wsj.com/article/SB118584551204482942.html.

Investing Internationally

Do you invest abroad? If not, you should consider it - but how much? Typically, as a certain equities exceed target amounts within a portfolio, financial advisors suggest rebalancing those amounts based on original targets. While international equities are no different, this article makes the case for and against exposure to overseas equities.

Link: http://online.wsj.com/article/SB118498005888573665.html.

Some suggestions:

1) Participate globally. International equities belong in most stock portfolios, because they assist in better diversification, they help investors participate in markets with higher rates of growth, and they are not perfectly correlated w/the US market (for more on this see previous post - http://marketlevers.blogspot.com/index.html#2178961660242578272.

2) Risk Remember the risk vs. return tradeoff, particularly for "emerging markets". Although the recent equity returns for markets like China have been very good, they are also more volatile, so these are long-term holdings, and shouldn't be too large a percentage of your overall portfolio.

3) Multinationals: By virtue of their scope, the article mentions stocks like GE and Coke that are essentially global investment plays. Keep stocks like this in mind.

One potential oversight of the article, however, is the role of "currency risk" and/or the impact that a particular home market's currency can have on your return once your holding's gains are converted back to dollars. Keep this in mind, but I'll address in a later post.

Inside money is still on REITs

Although I was never a heavy real estate investment trust (REIT) investor, those of you that were invested in these securities have done exceedingly well over the past 3 -5 years, and at lower overall risk thresholds. That being said, the market thus far this year has been flat to negative, and it looks like concern over interest rates, and recent deal multiples, are partially to blame. Insiders at major REITs feel disagree however, to the tune of 60MM in insider buys during the most recent quarter.

Judge for yourself: http://online.wsj.com/article/SB118471766230569645-search.html?KEYWORDS=reit&COLLECTION=wsjie/6month.

At the end of the day, one fundamental question is whether or not (given the current investment environment), there's a better place to park one's money. The stock market's a little frothy, and the ultra-wealthy have been placing bets in alternative investments like art and real estate for a long time. If you believe that the market may be at a mid-term top, and commercial or multi-unit real estate is reasonably priced, then who's to say that the REIT boom can't continue?

LaSalle/ABN - aka "What to do with your company stock?"

Came across a very topical article on "net unrealized appreciation", which is a method that can be used to minimize taxes on stock that you hold in a 401K. In my opinion, this is especially useful for those of us that may be anticipating a separation from our longtime employer, LaSalle Bank. I'll provide the link below, and then summarize briefly.

Link: http://online.wsj.com/article/SB118436150342166169.html?mod=pj_main_hs_coll

Summary:
1) Leave your job.
2) Withdraw your company stock from your retirement plan and move it to a taxable account.
3) During same calendar year, move the remainder of your assets out of your former company's retirement plan. These can be moved into a retirement plan.

Why would you do this? If you hold the stock until the age of 59 1/2, you can minimize your income tax on the holding to the max capital gains rate (currently 15%). For those of you in the 35% tax bracket, this will save you 20% on your taxes.

Please see the article for details, and see this posting for more tips directly from the source - Fidelity: http://www.fidelityresearchinstitute.com/.

Index Investing - ETF Style

Agile Investing

Do you believe in efficient markets? Well maybe you do, maybe you don't, but for those of you that may feel like the incremental effort involved in finding the right portfolio of stocks or mutual funds just might not be worth it, there are several relatively inexpensive resources that allow you to build solid portfolios via ETFs (exchange traded funds). Agile Investing is a solid, inexpensive resource that helps you do just that.

Link to current ETF portfolio allocation here: http://www.agileinvesting.com/index.cfm?menuitemid=194&menugroup=SubscribeHome&CFID=43085072&CFTOKEN=72239113.

Chartwell Advisors

Another worthwhile source, via an ETF newsletter, is Chartwell Advisors. Authored and managed by Carlton Delfeld, this is a solid source for ETF options that will allow you to "super-diversify" by allocating your positions globally. While it's a great initial review of ETF options, after a couple of months you will get most of what you need. The portfolios that Carlton has designed serve as a great base reference. Review the risk profiles and returns (vs. appropriate benchmark) for each, and then craft your own...

Link: http://www.chartwelletfadvisor.com/

International Markets - Historical Returns

Access to global equity markets is continuing to get easier for the average American investor, through ETFs and brokers that provide trading capabilities in foreign markets (e.g. TD Waterhouse, eTrade). Given that, I located some historical data, through Vanguard (I think) on the average stock returns for various International markets. Please forgive the size of the image!

Some stocks I recommend...

You will see more of these posts, but based on reading and other research that I've done (mostly reading), I am recommending the following stocks (see below). I'll monitor their performance over time.

I'm sure at some point, there are specific disclaimers that would be necessary, if I were some type of special investment advisor (I'm not). All I can say is that I've offered very profitable stock purchase advice in the past, but the date that you BUY and SELL have a significant impact on the actual RETURN that you will encounter.

So "Buyer Beware" but good luck:
- ALGN - favorable mention in WSJ - hedge fund has performed very well based on backing a recovery of these "invisible" dental braces (new to the market); the value prop is very compelling and they recently won a major patent case

- HSBC - favorable mention in Kiplinger's - although they've experienced recent sub-prime mortgage woes, with a P/E of 13, this is a global banking player, yielding a 4.3% dividend, that is significantly undervalued

- FPL - favorable mention in Kiplinger's - recent utility standout that has recently disappointed, but has significant wind-power investments and a large, growing energy customer base (3% annual dividend yield).

S&P Correlations by Market

If you're like me, you've searched for stocks that go UP when the S&P goes DOWN. The following graph I saw recently shows the correlation between a specific country's stock market and the S&P 500, which provides some guidance on this topic: