Wednesday, April 29, 2009

Magazine Covers As A Contrarian Indicator

I wrote recently that when cab drivers and shoeshine men start giving the public stock tips, this is a sure sign of a market top.
Another very reliable—but not perfect (nothing is)—contrarian indicator is using the covers of popular magazines to gauge what is most likely not going to happen.
The link below is to an article describing this phenomenon, with the topic being the probable direction of oil prices. The April 20th Newsweek cover's title is "Cheap Oil Forever".
Need I say more!

It was only one year ago that the majority of the media coverage around the world touted that based upon the unrelenting global demand for oil; prices were headed towards $200 per barrel. Since then prices have plummeted, creating an opportunity over the past several months to pick up high quality petrochemical related stocks, at bargain basement prices, with exceptional yields.

Investing lesson:
Magazine covers are really great at informing the public about what has already taken place, and very poor at proving insight as to the future direction of any given topic. That’s why they call them “reporters” not “forecasters”.

Sunday, April 26, 2009

Are Some Annuity Products Ponzi Schemes?

A Ponzi scheme involves a scenario where there is never enough money to pay all investors, with one investor’s money being used to pay other investors their promised returns.
There are two key ingredients to most Ponzi schemes:
1.   A “huckster” who offers a too-good-to-be-true investment opportunity.
2.   A willing investor that wants to believe (so I guess they do) that you can get something for nothing.
The two emotions that can wreak havoc on investment success are greed and fear.  Human nature will always allow for the self and promulgated perception that there is such a thing as a “free lunch”.
Over the past decade, insurance companies have offered products to consumers with features such as:
1.   Stock market returns with no stock market risk.
2.   Guaranteed income, even though the annuity value has gone down.
I have been warning the public about the risk posed by “too-good-to-be-true” annuity products for over a decade.  While most “get it”, there is still a minority of the public that do not.  Since the unraveling of the “promises” typically will not unfold until one or both (if married) investors die, mom and dad may go to their graves never knowing that a decision made years earlier may have blown up after their death.
According to the recent Wall Street Journal article “Getting Smart About Annuities”; the total annual internal fees of these complex “multi-promise” annuity products may exceed 4% annually.  My own research of various 200-page prospectuses (that investors fail to read) has concluded the same.  The article goes on to say, “due to the complexity of the contracts, they generally need to be bought through financial advisors”. 

I failed to mention earlier that the commission a so-called “financial advisor” can earn at the point-of-sale on these products can range from 4-15%.
1.   Bernard Madoff offered his illusion of high returns via numerous placement agents across the country that were paid handsome commissions for directing the business to Madoff. 
2.   Insurance companies market their illusion of high returns via agents and brokers who are paid handsome commissions. 
3.   As with Madoff, the vast majority of annuity peddlers can tell you how much in commission they will earn, but are unable to describe how the investment works, both initially and over a long period.

Let’s summarize the key points of these complex annuity products:
1.   Your money can get the return of the stock market, with the safety of a CD.
2.   You can receive a guaranteed income of 4-7% annually, regardless of how the investments you choose perform.
3.   Many agents suggest to the investor that since the insurance company is bearing the risk if the stock market goes down, the investor need not worry about diversification and can go ahead and invest 100% in stocks!
4.   Annual internal fees can exceed 4% annually.
5.   The annuity peddler is paid 4-15% in commission up front at the time of sale.
Another Ponzi Scheme

The insurance companies that market these gimmicky products are in essence running this part of their business like Social Security, which by design, is a Ponzi scheme.  With Social Security, the retirees are paid retirement income not from the capital that has been contributed or grown via the retirees’ lifelong contributions, but instead are paid from the new contributions from current contributors.
As with Madoff, if and when the whistle is ever blown on this game of musical chairs, millions of investors (or their heirs) will be left standing, wondering what happened.
Investing lesson: 
There is no such thing as a free lunch.  Never has been, never will be.

Friday, April 17, 2009

I Could Not Have Said It Any Better!

During virtually all bear markets, a point is reached that is later defined as the "maximum point of pessimism”. It is this author’s belief that this point was reached 3/9/2009. The market has rallied over 25% since then.
Two of the greatest (if not the greatest) roles a wealth manager plays for his or her client are:
  1. Ensuring that the client understands the risk/reward relationship of the portfolio.
  2. Administering to the client a “vaccine” that can protect him or her from making poor decisions at the maximum point of pessimism. Like all vaccines, it works for most--but not all--who are given the shot. In this case, the shot is ongoing investment education and candid advice as to what is most probably the best decision regarding the management of one’s wealth.
I recently came across a wonderful summation that captures not only why investors should avoid selling at bottoms, but also the great potential benefit that awaits those who continue to own the right mix of stocks, bonds, mutual funds, etc.
“The recession is going to end some day, probably sooner than later. The world economies are going to continue and re-surge their growth once again. There are significant numbers of truly great businesses that have proven themselves capable of weathering the storm. They are financially strong with great balance sheets and strong financials and the market is currently pricing them as if they are going out of business. This represents possibly one of the greatest opportunities for investors in a lifetime. As professionals, we are obligated to help our clients overcome their fears in order to reap the potentially large returns this crisis has created. Buying low and selling high is the oldest and most sacred of investing principles.”
Chuck Carnevale, Chief Investment Officer/Co-Founder of Great Companies, Inc.
Investing lesson: Buy low, sell high!

Tuesday, April 14, 2009

The Recent Market Rally: What Comes Next?

My forecast at this time is as follows:
I believe we are in a cyclical bull market, with the potential for the S&P 500 index to reach 1100-1200 over the next eighteen months.  Like any period of time, markets seldom move in straight lines and this potential upward trend shall likely prove no different.
The unprecedented government spending and related record deficits and a potential increase in inflation may likely become the next ticking time bomb, as we get closer to 2011.
It was only weeks ago that consumer/investor confidence was extremely bleak.  Now, with the recent 26% run-up in stock prices, investors, financial advisors and the media are in a much better mood.  The problem is that, fundamentally, not that much has changed in the past month, other than:
  1. The politicians in Washington finally figured out that paying attention to the 50% decline in the stock market is something that the majority of Americans want them to pay attention to.
  2. From a technical standpoint, many stocks, on a valuation basis, had reached very low valuation levels, to the point that like a magnet, money from the “sidelines” got pulled in to take advantage of the “blue light special” that many stocks were offering.
At this point, based upon the recent run-up in stock prices, it is very important to not chase returns and to maintain some cash on the sidelines should the current run-up reverse its course and decline 10% or more from it’s recent high.
Investing lesson: The cyclical trend is most likely upward over the coming 6-18 months, but this journey will be filled with many ups and downs, which is how the stock market works.

Monday, April 13, 2009

The Lunacy of Ratings Agencies and Warren Buffet

I would place bond-rating agencies, such as Moody’s, in the same boat as economists and weather forecasters, both of which are well known for not being very accurate in their predictions, but closely watched and given significant status, nevertheless.

Despite a rock-solid balance sheet, Warren Buffett’s company Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) lost its triple-A rating recently, with Moody's downgrading the company. As a contrarian, I think this announcement contains a hint of optimism and here's why:

Said without any sugar-coating, Moody's and its main competitor Standard & Poor's have had (and still have) a dismal record of predicting past and current developments “in advance of the results”. These ratings companies have a stellar track record of confirming what has already taken place, with the typical accompanying lower valuation of a company’s stock price already occurring prior to their downgrade of the company. In weather forecasting terms, they are great at confirming where the tornado touched down, after it as knocked down the homes, but poor at informing investors of where the financial tornado may hit, in advance. Instead of “fore”casting, I think a better term would be “after”casting.

As it pertains to Mr. Buffet’s Berkshire Hathaway, the recent downgrade is a classic contrarian buy signal. In the mutual fund I manage, we are increasing our stake in (BRK-B) as a result!

For most individual investors, buying (NYSE: BRK-B) at a current share price of $3,072 (4/13/09) is simply not prudent, as the high share price requires a portfolio of at least $60,000 to allow this stock to be no greater than 5% of total portfolio assets. Prudent diversification principles suggest that any individual stock not comprise more than 5% of an investment portfolio.

Investing lesson: never place weight on people/companies that are really great at telling you where the storm has hit, but very poor at informing you of the need to seek investment shelter in advance.

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