the supreme court, capitalism and israel

004CHINO HILLS – What I’ve been reading this holiday season.


The Economic Stimulus Plan: What I really think (Part 2 of 2)

CHINO HILLS, California – In addressing the current economic malaise that we find ourselves in, people focus a lot of attention on the expected tangible effect of the economic stimulus plan on the economy. Less, if any, attention is given to the psychological impact of having a plan in place.

Let me comment on the tangible effects first. The passage of the stimulus bill in the House of Representatives was notable for the absence of even one Republican vote. This reflects the philosophical and ideological differences that divide the left and the right. Both sides of the aisle agree that something needs to be done. The manner and priorities within the stimulus package is where the differences lie.

These differences are rooted in the continued debate over the level of involvement of government in the day to day lives of its citizens. Republicans, in general, cling to the mantra that less is better.

It is probably fair to say that both Republicans and Democrats agree that a combination of both direct spending by government and tax cuts is necessary within the stimulus bill. The proportion by which the pie is divided between these two is where the bickering starts.

Putting money in people’s pockets via tax cuts is the Republican way of conforming to the less government is better mantra. Direct spending via the likes of infrastructure investment and social/entitlement programs is what Democrats have focused on.

Each approach will have their stimulative effects. It is the effectiveness of these effects that are the bone of contention. In a sense, each involves a certain leap of faith given the severity of the current crisis as well as the size of the proposed stimulus package. In Part 1 of this missive, I had mentioned the inexact nature of economics. This reality lends itself to all the manner of seemingly reasonable justifications for the various approaches to attacking the crisis. Another reality is that even economists agree that no one really knows the final outcome coming out of this stimulus package.

So, in spite of all the noise we hear, no one can persuasively argue that there is the one perfect solution to resolving this crisis because no one really knows what it is or even if there is one. This takes us back to square one where everyone knows that something needs to be done and we can’t agree on how to go about doing it.

This brings me to the area that has not been the focus of much discussion – the psychological impact of having an economic stimulus plan.

To those of you who have followed my notes, I have always contended that uncertainty is Kryptonite to the markets. Uncertainty does not allow the formation of reasonable expectations upon which we can base some future action. This leaves us stuck in place going nowhere fast.

At the end of the day, it is the psychology of confidence (or the lack thereof) that will determine how fast we can get out of this rut. For decision makers (yes – that includes you, the individual consumer) to finally make decisions which will have the effect of driving the economy forward, they need to have some level of confidence that their decisions now will not negatively impact their financial well-being in the future. A prerequisite (conscious or unconscious) for making these decisions is an underlying confidence that things are being done to address the current problems and move us all forward.

That things are being done…

We will never end up with the perfect solution even if we are to divine that there is one. Thus, I sincerely believe that any stimulus plan (in whatever form we finally end up with) is better than not having one. The naysayers will probably come up with something along the lines of – “what if this is all totally wrong and even after all this spending we come back to where we are right now?” I would say that – well, how would we ever find out if this was the wrong (or the right, for that matter) approach if we didn’t try it.

In all likelihood, the implementation of a stimulus package of this size will involve a lot of trial and error on the part of those mandated to carry out this task. There will be a lot of mistakes that will be made along the way. There will also be a lot of things that will be done just right. I believe that we will get more things right, learn from the mistakes and get them right.

Let me end by saying this – something needs to be done and done quickly. When the final accounting is done, we will look back and see that getting things moving at this time was the right decision after all.

The Economic Stimulus Plan: My attempt at deciphering the why and the what (Part 1 of 2)

WEST COVINA, California – As I write this, the Bureau of Economic Accounts has just released its fourth quarter Gross Domestic Product (GDP) report showing that the US economy contracted by 3.8% over that period. Now that I’ve gotten that sentence out of the way, let me assure you that I try to keep my notes as “user-friendly” as possible so some people actually keep on reading.

The focus on this note is to try to provide a simple (hopefully not simplistic) guide to relate what’s going on in our economy and what the current economic stimulus plan aims to do to address this slumping economy. This stimulus plan has just been passed by the House of Representatives and will be taken up by the Senate next week.

To those of us who have taken Economics 101, the next few paragraphs will be basic. To those who haven’t please bear with me as I try to provide some simple explanations.

GDP is the over-all measure of what was produced by a country’s economy over a specific period of time. The GDP is arrived at by the total of Consumer Spending (C), Business Investment (I), Government Expenditures (G) and Net Exports (Exports (X) less Imports (M)).

Consumer spending has generally accounted for 2/3 of the US economy. This fell 3.5% in the 4th quarter of last year. Business investments fell by 12.3%. Government expenditures rose 1.9%. Exports were down 19.7% while imports were down 15.7% with the over-all effect being that the US made slightly more money from exporting goods and services than what it made from importing goods and services.

I hope I haven’t lost you so far (or maybe I have but hey it’s a tough subject – economics).

The bottom line is that consumers are not spending as much money because they don’t have it (or if they do, they’re stashing it under the mattress), businesses are cutting costs like crazy and the government is trying it’s best to keep the economy afloat (by design or accident – I leave that for you to decipher).

Okay, now that we know that the numbers have confirmed what we already know, let us go back to the stimulus bill.

Essentially, what the stimulus bill is meant to do is to try to dump a boatload of dollars into the economy in a bid to re-inflate it. There are many ways by which they are trying to do this and I won’t bore you by trying to go into too much detail.

In general, there are 2 ways. The first is by directly spending the money, an example of which would be infrastructure investment in building roads, bridges, and schools – that kind of thing. The second method is by reducing taxes on both individuals and businesses with the hope that individuals and businesses would then have more money to spend.

Now, let’s have some perspective here. The size of the US economy is $14.26 trillion. If that figure represents a drop of 3.5%, then the value that has been lost by this economy would be a little over $500 billion. The economic stimulus bill in its current form calls for $819 billion in new spending and tax cuts. It would seem that the math says we are going to fix this in no time. Unfortunately, the real world is the real world.

First, the economy continues to slide with a slew of new lay-offs, a continued tightness in lending and just an over-all decline in production. As such, the value lost in the economy will continue to grow at least until the third quarter of this year (my guesstimate, don’t hold your breath). Second, assuming the Senate passes the bill next week and President Obama signs it into law, the bulk of the spending anticipated by this stimulus package will not happen overnight. Finally, no one can say with any degree of certainty what the over-all impact of this stimulus package will be as to its effectiveness and as to a time frame for when it actually makes a difference.

Economics is an inexact science (to say the least). Arguments, one way or another, for and against this stimulus package is underpinned by this lack of clarity. By the time, all of this is said and done and President Obama finally signs some stimulus package into law, all of us amateurs who deign to pay too much attention will end up being dazed and confused (whaaaaat?).

(To be continued – Part 2: The Economic Stimulus Plan: What I really think)

Where do we go from here?

WEST COVINA, California -As all of you who are paying attention probably already know, the US House of Representatives has voted down a bill to authorize as much as $700 billion for the purchase of the so-called “toxic” mortgages. As a result, major US equity market indices were down between 7-9% today.

It is easy to stop there and not look at the root of this slide. But I won’t.

The root cause of market volatility is uncertainty. Markets hate uncertainty because it does not allow for the formulation of reasonable assumptions to try to justify asset prices. This is where we find ourselves in – a situation where no one knows what the end game is.

So, where do we go from here?

Two possible directions would be (1) an alternative bail-out bill is crafted and rushed to Congress for approval and (2) the markets are allowed to sort out this mess.

The first option is the more likely direction of the two that I mention. I just can’t see Congress not doing anything to try to hammer out another compromise bill. Voters may not have liked the first bail-out bill but they will probably like less the idea of their elected representatives leaving everything to the markets. As this bill is negotiated, the markets will remain volatile throughout this period. It will remain so until the specifics of this new package are nailed down and people will have a chance to assess the likelihood of its success in resolving the current mess.

The second option will see more financial institution failures, personal and corporate bankruptcies, the continued rise of unemployment and a decline in consumer spending. The Fed, in concert with the rest of the world’s Central Banks, will try to mitigate and stem the effects of these events by infusing even more money into the markets but these efforts will be overwhelmed by negative sentiment from everything else that will likely happen.

Regardless of which path we eventually take, it is important to note that the markets, at some point, will come to a reasonable estimation as to the degree of damage these “toxic” mortgages will have. This point will come sooner than when the actual losses are written off, before all of the institutional failures end and before we actually see all the negative effects of this crisis. At that point, markets will likely enter a period of even more weakness before stabilizing and beginning the long road to recovery.

This point will come before the actual recovery of the general economy, probably 12-18 months before. So if we are looking at maybe 3 years before all of these consequences plays out, we may be looking at least another year before we see some kind of relative market stability, not to mention recovery. There will be plenty of opportunities to find value in the markets before that but be prepared for what should turn out to be a very interesting (to put it mildly) ride.

The Financial Storm of the Century

CHINO HILLS, California – Who would have thought that two of the most venerable names on Wall Street would announce their demise (at least as to their previous state) within hours of each other? If you haven’t already heard, Merrill Lynch, Wall Street’s third largest firm, will be acquired by Bank of America. Lehman Brothers, the Street’s fourth largest firm has filed for bankruptcy protection.

Alan Greenspan, in an interview over the weekend, called the current turmoil surrounding the financial markets as “…a once-in-a-half-century, probably once-in-a-century type of event…”

One of my clients sent me a link to an interview given by Prof. Nouriel Roubini of NYU’s Stern School. Prof. Roubini has always been someone whose opinions I have learned to take seriously. He has, at times, been a lone wolf in commenting on the seriousness of the current credit crisis that we find ourselves in. Thus, it is with some concern that I listened to this interview.

Prof. Roubini essentially says that we are not out of the woods as far as this crisis is concerned. He says there may be more bank failures in the horizon. He even suggests that our bank deposits may be in trouble given that the FDIC has only $50 billion in reserves to protect $1 trillion in deposits. He recommends “people with accounts exceeding $100,000 in value should spread their money – and the risk – among different firms.”

No doubt, such a call from a respected economist like Prof. Roubini is bound to create some panic and maybe even spur some minor “runs” on the bank. It is unfortunate that in many cases, bank failures are caused not by the actual financial standing of the bank but by a mad rush of withdrawals brought on by a “better safe than sorry” mentality. No bank no matter how big can withstand a sustained “run” many of which are driven by rumor and innuendo. Nevertheless, you cannot entirely blame the masses who may just be out to protect the totality of their life’s savings.

So what are we to do? If you do not have over $100,000 in one bank, you may not have that much to worry in terms of losing your money. You may have to deal with long lines, if worse comes to worst and you actually would have to take your money out from a failed bank.

If you do have more than $100,000, I will not be a proponent of strictly following the advice of Prof. Roubini without doing some other remedial action. The $100,000 FDIC limit has some wrinkles to it that actually allow you to keep more than $100,000 in one institution and still have all of it insured. The trick is in divvying up your money among different accounts. For more of how this works, go to the FDIC website. There is also this guide from the FDIC.

It is very easy to get lost among the trees in the forest especially during times like this when we are deluged by this torrent of terrible news. I have always been one who never panics when events and periods like this happen. Granted, this weekend has been worse than most. Nevertheless, if you step back and delve more into what Dr. Greenspan and Prof. Roubini ultimately say you may find some comfort in the fact that all those “Armageddon-like” prognostications are more fiction than fact.

Note the following:

“…a once-in-a-half-century, probably once-in-a-century type of event…”

– Dr. Greenspan

“Question: Truly long-term, are you still optimistic?

Prof. Roubini: yes.”

As Dr. Greenspan and Prof. Roubini say, there will be a time when all these challenges will be sorted out. When that time comes, a typical person will never know until they are well into that recovery. We will likely be through a period where the recession will be twice as long as normal (at least 2 years?) and where such a recession will be twice as severe as the last one.

Financial markets have a way of punishing the excesses of its participants. This is what is happening now. Left unfettered, markets will continue to exhibit “boom and bust” characteristics. If government has a role, in these markets, it would ideally be to exercise better regulatory oversight to limit these excesses and, in so doing, soften market volatility. I understand why government is acting the way they are acting right now (i.e. bailing out Bear Stearns, Freddie Mac, Fannie Mae, etc.). It may be easy to “Monday Morning Quarterback” this thing but I sincerely believe that we would not have gotten this far had government done their job properly in terms of their oversight functions. Now it’s causing more grief and costing taxpayers more money.

This is not to excuse the private sector’s getting away with the poor judgment that they have exercised. It is just that markets will eventually find a way to punish these recalcitrant market participants. But by then it will probably be too late, as it is in this case, for Main Street denizens who have or will lose their jobs, their homes and, God forbid, their hopes and dreams.

I try not to end my notes in a depressing manner so if I were to hazard a silver lining to all these it would be these. I hope that the failure of Lehman is a sign that the powers that be have finally come to the realization that failure in the markets is okay. That letting Lehman fail will serve as a warning that irresponsible behavior will have dire consequences. I hope that the removal of the “too big too fail” safety net (at least for now) will begin to weed out these irresponsible market participants. I hope that, when we look back at this day in 3, 5, 10 years, we can say that this was the beginning of an economic renaissance. For now, I can only hope. But I choose to hope for without hope what else is there to look forward to.

These are the times that try men’s souls

WEST COVINA, CA – When Thomas Paine wrote those words in his pamphlet “The Crisis”, I am pretty sure he did not have the current gyrations of the stock market in mind. Yet this quote pretty much sums up the feeling of many investment professionals who have seen several occurrences of this nature in the past.

Was it really only a month ago when the S & P 500 hit an all-time high of 1555(3)? Since then it has fallen by almost 10% from that peak as of yesterday’s market close. The question is, is that it or is worse still to come?
Well, I am not in the business of predicting the day-to-day fluctuations of the market. Indeed, nobody can do that or at least nobody can do that with any level of consistency or certainty. In my formative years as a financial professional, oh – about 10 or so years ago, I was called to do that. There was always something I could point to in conjuring a reason for why the markets did this or did that on any particular day. I could also conjure up a prognostication for what the markets would do for the following day or the following week and support such a view with seemingly compelling justifications. Predictably, nobody would call me out on how those predictions would eventually turn out. You see, predicting short-term market direction has a short “news cycle”. The following day or as in many cases, the following hour, the markets would do something and someone else would come out with their own opinions on what the markets would do and why the markets would do that. Again, nobody would call out this analyst on these prognostications. That was my previous life and I have since grown up.

See, in our current reality of shortening news cycles, 24/7 media coverage and the world of blogosphere, we are bombarded by all this “noise” which tends to sensationalize and exaggerate events like these as if these had never happened before. In short, our memories have become shorter.

It would be okay if it stopped here but it doesn’t. The absence of context under which all this “noise” is provided, in many cases, leads to real decisions by typical investors, which we can characterize as “panic”.

It is this phenomenon that can lead to real damage to one’s financial plan. The decisions that are made under this scenario are similar to decisions made in panic mode in the other facets of our daily lives. These decisions tend to be irrational, not well thought and reasoned. Panicked.

As I continue this note, let me begin with these words of caution – past performance may not be indicative of future results.

Having said that let me try to provide some context to the “noise” that we all hear, all the time.

Markets go up, markets go down. More importantly, nobody can consistently predict the short-term movements of the markets.

Given that fact, let me reiterate some of the points of discussions that we have had.

Investing for retirement is a long-term proposition. Thus, short-term market performance should not be an overriding consideration in investment decisions. Many have the erroneous assumption that the time horizon for managing retirement assets stops when we retire. What’s left out is the reality that we will spend 20 or even more years in retirement. Even in retirement, we have to make sure that your retirement assets continue to be managed with the appropriate perspective to avoid the greater danger of running out of money while in retirement.

Diversification is key to managing risk. We have discussed the appropriate portfolio mix for your retirement assets. The construction of your portfolio incorporated diversification among various investment options to provide some level of protection to market fluctuations.

Rebalancing your portfolio should be done in a regular and consistent manner. Because different investments perform differently in different times, rebalancing your portfolio is essential to make sure that you are not overly invested in any particular investment. Another way of putting it would be that rebalancing ensures that you maintain the appropriate level of risk in your portfolio(4).

These are some of the keys to a successful retirement savings plan.

Let me end this note by citing one statistic. A study published by Dalbar(1) estimates that in the 20 years ended December 31, 2005, the average stock fund investor achieved a total return of only 3.9% per annum(2). The return of the average stock fund for the same period, on the other hand, was 11.3%(2).

The reason for the discrepancy according to the study – “unhealthy investor behavior”.(2)

The bottom line is this – the markets will do what they do, it is what individuals do in reaction to the market that determines the success (or failure) of their retirement savings portfolio.

Stay the course and continue to invest in line with your objectives.

(1) DALBAR develops standards for, and provides research, ratings, and rankings of intangible factors to the mutual fund, broker/dealer, discount brokerage, life insurance, and banking industries. They include investor behavior, customer satisfaction, service quality, communications, Internet services, and financial professional ratings.
(2) Source: Quantitative Analysis of Investor Behavior by Dalbar, Inc. (2006) and Lipper. Dalbar computed the “average stock fund investor” return by using industry cash flow reports from the Investment Company Institute and the S&P 500® Index. The “average stock fund” return represents the Lipper Fund Equity Lana Universe. Past performance is not a guarantee of future results.
(3) Source:
(4) Neither diversification nor rebalancing can ensure a profit or protect against a loss.