The Securities Market

Investing in the securities market is never simple. But you can simplify the process somewhat by specifying your aims. Financial media reports and suggestions often fail to make this point.

Are your goals short term or not? Are you taking proper consideration of age? What are your feelings about risks?

Consider the economy. We have been in more than an ordinary recession. It may not bounce back for several years.

And inflation will be a distinct prospect, probably quite heavily, within a couple of years.

Economic stagnation and high inflation could stifle corporate profits. ( See the Earl J. Weinreb NewsHole® comments.)

Brokers Acting as Principals

Be careful that some of the brokerage transaction you make are just simple broker transactions. In many instances, the broker may be acting as a principal, selling you a security from his inventory, or perhaps buying the security into his inventory.

That could actually represent a very short period, an in-and-out transaction with another party. Nevertheless, the broker is technically not a broker but a dealer.

That is legal provided his markup is reasonable. In many instances a 5% markup is not acceptable when the security is traded in a liquid market.

The Financial Industry Regulatory Authority or FINRA has been attempting to fine tune the activity. ( See the Earl J. Weinreb NewsHole® comments.)

State and Local Public Employee Retirement Programs

State and local public employee retirement programs now have unfunded liabilities of about one trillion dollars. according to Pew Center on the States. Despite the current publicity the subject is getting, most folks have no concept of the real problem, nor the solution.

Unlike the federal government in Washington, states and local entities cannot print money. They cannot continue to keep borrowing either.

Talk of fed-enabling legislation for states to go bankrupt is not a practical solution. The public employees’ unions will not like the haircuts and shaving bond prices will starve the source of future financing, as well as decimate smaller savers in those bonds.

But there is no reason to panic if public employee pensions are negotiated to realistic levels along with state and local budgets.

Financial Odds

Most of us are not familiar with the odds of finance and it affects our outlook on financial matters.

An example: Flip 100 coins, heads or tails; there is a 75% chance of a streak of 6 or more. And a 10% chance of a streak of 10 or more

Look what this does when we observe analysts and securities’ markets. You hear comments after market closings about events which really reflect randomness. But the comments attribute specific causes that occur only in the minds of the commentators. ( See the Earl J. Weinreb NewsHole® comments.)

Misguided Government “Experts”

An idea of just how unsure and inexpert the “experts” can be: The Federal Reserve Bank is still on its path of buying $600 billion of government bonds. This inflates the economy by, in effect, printing fresh currency. The Fed intention is to rouse the economy

But at the same time, the Fed is allowing some big banks to raise their dividends, which soaks up capital and their lendable funds. The Fed, after all, wants to rouse the unemployment problem.

While some banks, instead, use excess cash to buy up shares. All this adds to a mix which makes the Fed’s actions very imprecise, to go along with the rest of their their seat-of-the-pants decisions.

Faulty Retirement Planning

Retirement planners use dubious assumed models. They take into account investments, forms of diversification, along with outlay plans and a number of probabilities. One may be Monte Carlo simulation, a well-known model used by investment advisers for this purpose.

But such investment planning fails to work for many reasons.

A major financial market meltdown is one. And other unforeseen events happen; illness, a job loss, business failure, unexpected educational expenses. The result of a lifetime of retirement planning is often failure.

The solution is to be realistic. Be prepared to work at least part-time past what you had originally thought would have been retirement age. ( See the Earl J. Weinreb NewsHole® comments.)

A Financial and Legal Analytical Can of Worms

Law suits can arise when credit rating agencies, who judge the quality of bond or derivative issues, are considered the cause of investors’ loss of money. Making it easier to sue can thus open a can of worms.

The First Amendment is supposed to guard free speech. That usually protects financial analytical reports. Including opinions on Structured Investment Vehicles or SIVs, or derivatives, or any form of corporate and municipal bond.

Can analysts and their employers be sued for malpractice if their opinions have been wrong? Or are they covered by the First Amendment? What does any court decision do to those who evaluate due diligence in the future?

Every so often a move is made to sue credit agencies for alleged malpractice.

Currency Trading Complexities

When trading the dollar overseas, a variety of international problems can make that currency stronger, situations that also affect the value of the Euro and foreign currencies in different ways.

And then other factors come into play. Such as rising oil and energy prices, with their effect on the American economy. The impact on the dollar can be opposite what it would ordinarily have been with respect to the other currencies.

We import oil. Were we producing our own energy, our dollar would be much stronger than it is, internationally.

Evaluating Economists

Economists generally agree on basic tenets of economics. These have to do with the long-term effect of deficits, and the inevitability of inflation as a result. They usually also agree on incentives for business and, to some extent, on tax cuts for small business, in efforts to increase jobs. Other than for basics, their opinions differ.

I have often said I’m not impressed by their awards, especially Nobel prizes.

Economics involve many complex variables and facts, unknown and the unknowable, and can be difficult to understand. It definitely is not a science.

Economists can see what has worked well in the past and what has not, but there is no predictability. Modeling and planning has not worked properly in the past, and will not in the future.

As one observer has said, “economics is history trying to be physics.”

Politics plays a big role in the thinking of many. It produces the variations we are accustomed to, as an accommodation by economists tuned to the political interests they may favor.

There are a handful in which I have more confidence. Examples: Milton Friedman, Friedrich von Hayek, among others, whose work I follow.

Economist Opinions

When you listen to economic opinion, find out what the politics of the economists are before taking their advice.

Political slants color their opinions. Economics is not a true science, so comments can diverge along those lines.

Look into track records; many of those lauded by the media have been consistently wrong for decades or merely misinterpreted. John Maynard Keynes is an example.

Also, do not be impressed by awards, especially Nobel prizes, as some have been awarded primarily on the basis of politics.

Dodd-Frank: A Classic Example of Over-Regulation

Not a day passes without a new adverse revelation about the Dodd-Frank Act, which had been cooked up by Congress less than a year ago, to cure everything that hinted at financial malaise.

The actually unfinished result still has more than 530 regulations, with 60 studies and about 90 reports and we haven’t seen the end of them. Sarbanes-Oxley legislation, whose negative impact outweigh the positive, had 16 regulations that have helped the exodus of major corporations to flee overseas.

The Law of Unintended Consequences is always overlooked by politicians because it’s inconvenient when campaigning for office.

Deep Recession as a Government Failure

In years before modern regulatory controls, free financial markets regulated themselves. Severe bubbles were rare, though economic cycles were common, as they still are.

But recessions were self-correcting, because they were market-oriented. Every economic downturn was brief, self-repaired by inherent market instincts.

There were no strict regulatory powers around, with no artificial tinkering and meddling by use of economic theories or any correcting stimulus. Yet, the steeper the downturn, the faster and sharper the recovery in every instance.

The problem with a stimulus is that most are political and have no real economic function. Moreover, they are usually the wrong kind. That is, they are made to act too far into the future. They begin to work after the actual economic recovery. Natural market repairs are much faster than a political stimulus, which, as we know it, is merely a misnamed bait and switch device.

It should instead be called what it actually often is, a political slush fund.

Government’s Expensive Help

I have often noted how politicians rely on government to remedy all the ills of a relatively small population, while imposing more socialistic restrictions in that effort.

While the taxpayer/consumer pays dearly for ineffective efforts.

As examples: Borrowers who use credit cards, or take out mortgages and loans, make stupid decisions. Government bureaucrats will tell you we need more regulations and financial product safety. Yet you cannot legislate or regulate against stupidity without consequences. Those merely translate into more costly bureaucracy.

Larger print in consumer contracts will surely help. Along with better schools we already pay for.

What government effort actually does is make credit more scarce. And therefore more expensive for those with good and bad credit alike.

Big Government and Empty Promises of Assistance

Too many politicians rely on government to remedy all the ills of actually a relatively small percentage of the population. They never fail to use an economic sledge hammer to accomplish this goal.

To cure laments of a small set of the population, they seek remedies that hurt the majority. The result is the same: Bigger government. Greater advances to the socialist state they insist they are not really for.

Critics feel their sole political intention is merely to create that bigger government and not produce practical help.

Stress Test Fallacy

An example of how foolish the periodic use of so-called Stress Tests are for evaluation of banks’ strength:

Firstly, publicizing the results as in the past is dangerous to the economy. The term itself is a no-no because of its psychological implications with regard to the economy and the stock market.

Secondly, little of the public, and only a few in the financial community, fully know what each test is supposed to reflect.

Furthermore, in an emergency, the amount of capital a bank has can be wiped out because of mark-to-market accounting principles that may be applied.

In the past. these actions caused the very financial emergencies they supposedly were meant to avoid.

Bank Stress Tests

Stress tests for banks, suggested by regulators, are poorly designed because they’re composed of too many arbitrary factors; each may have weightings with only indirect relativity to each other.

Of the several factors, not one by itself is of predominant importance in reflecting bank safety. The ratio of doubtful residential mortgages to capital, for example, or commercial mortgages to capital, or types of capital, or what constitutes tier 1, or loan defaults, and effects of potential general unemployment, all add up to figures which become too vague,

Experts ought to seek decisive answers on which to base banking decisions. Financial officials and boards must now make subjective decisions to act upon such stress tests. And they can be wrong, as they have been in the past, in dealing with financial meltdowns.

Financial Advisers Employ Business as Usual

Are financial advisers truly working on behalf of their investors?

It appears that they are doing what they have always done in the past; perhaps satisfactory only within certain standards and reasoning.

Some are still resorting to alternative investments, which are being designed to offset weakness in stocks and bonds. These investments are suggested for clients in the form of currency trading, commodity futures and private partnerships.

However, not only are these type securities volatile, they are expensive; though fine for the advisers.

Larger accounts are getting the use of math models, which don’t always work, and so-called structured products, which gets back to the potential 2008-2009 financial meltdown problems.

When big fees are involved, many financial advisers employ business as usual. ( See the Earl J. Weinreb NewsHole® comments.)

Your Investment Odds

Here is a simple way to improve your investment odds, based on my experience on studies of now about 1,600 strategies, along with their pros and cons, and most importantly, the discipline of usage.

To sum up a simple lesson that takes little effort: Once you learn the basics, turn off the constant noise and chatter that you get from the financial media.

All that mostly repetitive nonsense, does more harm than any possible good. ( See the Earl J. Weinreb NewsHole® comments.)

Following the Professional Market Traders?

Big market traders earn big money in up and down markets. Can their method be copied by Main Street as well as others on Wall Street?

Giant investment bank/trading groups have been specializing in high-frequency trading, and now account for a large segment of all computer-generated trading on the NYSE. Their mathematical model/code has worked for them. These math models generally do well, until you hear of an eventual foul-up.

Mathematical formulas are not for Main Street. They are not even for many on Wall Street.

Always remember those who failed with collateralized debt in 2008, and at times, years earlier. ( See the Earl J. Weinreb NewsHole® comments.)

A Small landlord’s Investment Prospects

Many smaller would-be landlords are considering buying rental properties as a means of making better returns from investments.

Diversified corporate bond funds of lower credit ratings, but without outlandish credit risks, still offer decent yields, as do REIT mutual funds, which invest in real estate equity trusts.

Still, individuals who are familiar with small properties may find bargain real estate that will offer a decent return and possible capital enhancement.

But there is a danger in holding real estate on a small scale. It may derive from local regulations which you should know intimately. And you must be prepared to do most of your own small repairs, which can be costly when assigned to outside mechanics.

FINRA Regulations

FINRA, or the independent Financial Industry Regulatory Authority, operates from Washington, DC, and New York City, with fifteen District Offices.

It’s involved with registering and educating the industry. It examines securities firms; along with writing and enforcing securities rules. FINRA also informs and educates the investing public, and provides trade reporting and other industry utilities. The Authority administers the dispute resolution forum for investors and registered firms.

The organization performs market regulation under contract for the NASDAQ Stock Market, the American Stock Exchange, the International Securities Exchange and Chicago Climate Exchange.

However, they are of help only to those who constantly are aware of investment principles on their own.

Stymied Stocks

The Congressional Budget Office has indicated from its studies that U.S. economic growth will average a little more than 2% a year over the next 70 years. It had been about 3,5%, from the 1950s on.

There are many reasons why estimates for future economic growth are dismal, including our enormous debt which must be serviced. Moreover, it’s highly likely future interest costs will be much higher than they are today.

The specter of inflation all this imposes makes stock market growth difficult. (See the Earl J. Weinreb NewsHole® comments.)

Restricting Short Selling

In a previous report I mentioned the usefulness of short selling; selling borrowed securities, in the hope of buying back the borrowed security at a lower price in the future.

Without short selling, markets would become overvalued and would not be priced as rationally as they generally are.

However, during financial meltdowns or other emergencies which may affect markets from properly functioning, it may be necessary to temporarily stop such trading.

The SEC has placed restrictions on the use of short selling after a security is off 10% on the day. Unwise, because policing is difficult with the rise of lightning-fast computers. ( See the Earl J. Weinreb NewsHole® comments.)

Testing a Financial Guru

Want a quick test of someone who considers himself a financial guru? Ask them about buying bonds with the threat of inflation.

When he starts talking TIPS, (for inflation-protected Treasury bonds) without asking how long you intend to hold the bonds, he has flunked the first step.

Then ask him to explain the duration principle behind the purchase of bonds. And how the usage of duration can overcome the effects of inflation. Chances are he will flub that too.

Want my answers to that question? ( See the Earl J. Weinreb NewsHole® comments.)

Financial Adviser Requirements

Most investors don’t need financial advisers for three basic reasons.

First, basic investing principles are easy to master. Secondly, what to buy is simple in the age of index funds. There is no reason to attempt to buy individual securities. I have explained why in much of my past comments and books.

Importantly, adviser fees eat too much out of investment earnings. I repeat this constantly. Adviser fees can account for as much as 20% and more of annual investor earnings.

The garden variety of advisers, that is the bulk of them, are not worth the money because their expertise is run-of-the-mill.

On the other hand, investors who have estate and tax questions need legal advisers. That has little to do with portfolio selection. ( See the Earl J. Weinreb NewsHole® comments.)

Short Selling Market Advantages

Populist politicians and the bulk of the media give the impression that short sellers are bad. And that short selling causes much of our financial problems.

There are times when it does. But short selling usually has a proper function in the securities business and our economy.

This is the practice of selling borrowed securities, in the hope of buying them back at lower prices in the future.

Without short selling, overheated, overvalued securities would continue rising and add to dangerous bubbles, and thus prevent markets from being priced more rationally.

Short selling generally keeps markets honest. Dictating when to stop or retard its use will only exaggerate market extremes. ( See the Earl J. Weinreb NewsHole® comments.)

Aggravating Financial Meltdowns

Short-term, in-and-out, frenzied trading by the pros is what aggravates financial meltdowns. It is the segment of Wall Street that I always avoid in good times. Imagine what can happen in dangerous markets.

This is precisely what aggravated the 2008/2009 market selloff, aided and abetted with mark-to-market and short-selling.

True, erratic markets create opportunities for professional traders, particularly those I call inside players. But not the vast majority of investors. ( See the Earl J. Weinreb NewsHole® comments.)

Playing the Yield Curve

One of the strategies suggested in the financial media is the “yield curve.” This has to do with the difference in yields of the different maturities of U.S. Treasury bills, notes and bonds.

There is usually a normal difference in return, depending on years to maturity of the security. But this can change, depending on economic conditions and influences, including fiscal activity of the Treasury and monetary action by the Federal Reserve.

But playing yield differences is a timing, short-term exercise which is tough enough for pros to succeed at. It’s best that average investors forget about this strategy.

The AIG Panic Revisited

Human error was instrumental in the financial meltdown of 2008/2009,and various bubbles that we have had in the past.

In each case, there has been finger-pointing, usually by anti-business politicians and by bureaucrats whose immediate impulse is to blame big business and bankers; the usual scapegoats. That is the litany of criminalization in left-wing lexicon.

I have always blamed human error. Whether it be loose monetary policy of the Federal Reserve, in inflating currency, or inappropriate accounting rules for normal securities market situations, actions that hasten the ruin of investment liquidity.

In the case of AIG, the value of its derivative insurance coverage was also being determined on the basis of fictitious existing market value. This time, not on possible claims in the future, at the maturing of company obligations, but at supposed current valuations.

That produced a condition that induced premature bankruptcy in a panic venue; a rush to judgment when cool heads and hands ought to have been the hallmarks of expertise.

The AIG panic was evidenced by the rescuer’s paying of debts on the basis of 100 cents on the dollar to some bankers in this country and abroad.

Credit Default Swaps Are Back

Just a year or two ago CDS, or credit default swaps, were considered by liberal politicians to be the cause of the financial meltdown.

They thus conveniently forgot the real cause of the financial meltdown, which would have pointed to much of their past political activity. That financial debacle owed much more to Washington antics and influence than it did to Wall Street.

But Credit Default Swaps are back because they are needed in a burgeoning market by a number of industries, particularly big banks. Even the debt of General Motors Co. debt which doesn’t presently exist, but may in the future.

Dodd-Frank and Too Big to Fail

The Glass-Steagall Act, created under the Banking Act of 1934, was terminated during the Clinton administration. It had separated regular banking from investment banking activity.

However, it’s easier to talk about the problems of not having the legislation, than the separation of investment banking and ordinary banking, once the two have been so connected for years.

The question of proprietary trading arises. Both regular and investment banks had executed such trades, ordinary banks to a lesser extent. Moreover, such trading generally represented a very small, insignificant amount of activity and income.

Furthermore, the definition of what is a proprietary or “prop” trade is hard to delineate.

The result, with all our populist politicians, we have bombast, finger-pointing, and economic panic and damage.

We wound up with Dodd-Frank, a complex maze of regulations that has, as one of its missions, an attempt to separate commercial and investment banking. And preventing banks from getting too big to unwind as failures.

The result so far: Banks are getting bigger and the risk of failing is ever-larger.